What Is Forex Trading? A Beginner’s Guide

How the forex market works

Forex is short for foreign exchange. Every forex trade is an exchange: you take on one currency and give up another in the same action. There is no way to hold a forex position in a single currency, because a currency can only be priced against something else.

There is no building where this happens. Forex has no central exchange the way a stock market does. Banks, brokers and dealers quote prices to each other over a network instead. That structure is called over-the-counter, usually shortened to OTC. The price on your platform is your broker’s quote, built from what its liquidity providers are showing at that moment.

Because the market is a network rather than a venue, it does not open and close once a day. It follows the working hours of the world’s financial centres in turn — Sydney, Tokyo, London, New York — so it runs 24 hours a day, five days a week, stopping only for the weekend.

Forex is the largest financial market in the world by turnover. For a beginner that matters in one narrow way: in the most traded pairs there is almost always someone on the other side, and the gap between the buy and sell price stays small. It does not mean prices are easy to read.

It also helps to recognise who else is in the market. Most forex volume is not speculation. It is companies paying overseas suppliers, funds hedging the currency risk in their holdings, and central banks managing reserves. Retail traders are a small share of the daily flow.

What a currency pair means

Forex prices are always quoted as a pair, such as EUR/USD or GBP/USD.

The first currency is the base currency. The second is the quote currency. The price tells you how many units of the quote currency it takes to buy one unit of the base currency.

If EUR/USD is 1.0850, one euro costs 1.0850 US dollars.

Buying EUR/USD therefore means buying euros and selling dollars. Selling EUR/USD means the reverse. There is no neutral cash position inside a pair — you are long one currency and short the other at the same time.

Pairs fall into three groups:

• Majors — the US dollar against another large currency, as in EUR/USD, GBP/USD and USD/JPY. The most heavily traded, and usually the cheapest to trade.
• Crosses — pairs without the US dollar, such as EUR/GBP.
• Exotics — a major currency against a smaller or less traded one. These move less smoothly and cost noticeably more to trade.

A beginner has no reason to start outside the majors. The cost difference is real, and it is paid on every trade.

How retail traders actually trade forex

A standard forex contract is 100,000 units of the base currency. Very few private traders want delivery of 100,000 euros, and almost none want to fund the full amount.

So retail forex is normally traded as a contract for difference, or CFD. The currencies themselves never change hands. You open a contract with your broker that tracks the pair’s price, and when you close it the difference between the opening and closing price is settled in cash in your account currency. What that contract is and how it behaves is covered in what a CFD is.

Two things follow, and both matter.

First, you can sell before you buy. Because nothing is delivered, opening a short position is exactly as simple as opening a long one. You are not borrowing anything from anyone.

Second, you do not pay the full value of the position. You set aside a deposit called margin, and the position is larger than that deposit. This is leverage. The market’s move is applied to the full position size, not to the margin you put up, which is why leverage decides how quickly an account can be damaged. It has its own lesson: leverage and margin explained.

Position size is measured in lots. One standard lot is 100,000 units of the base currency, a mini lot is 10,000, and a micro lot is 1,000. Most platforms let you trade fractions, so 0.10 lots means 10,000 units.

The pairs available and the conditions attached to each are listed on the forex CFD page.

What moves currency prices

A currency’s price reflects what the market believes about the economy behind it, relative to the one on the other side of the pair. Four forces do most of the work.

Interest rates and central bank policy. The largest single driver. Money moves towards currencies that pay more to hold, so expectations about future rate decisions move prices long before the decisions arrive.

Inflation and growth data. Consumer price figures, employment reports and GDP releases arrive on a published schedule. Prices can move sharply in the seconds around them.

Trade and capital flows. A country that consistently sells more than it buys generates steady demand for its currency. This works slowly, over months rather than minutes.

Politics and risk sentiment. Elections, conflict and financial stress push money towards the currencies investors treat as shelter, typically the US dollar, the Japanese yen and the Swiss franc.

One point beginners routinely miss. All of this information is public and scheduled. The market does not move because inflation came in at 3%. It moves because inflation came in at 3% when the market expected 2.7%. The expectation is already in the price, so what matters is the gap between the number and the forecast. Reading a release without knowing what was forecast tells you very little.

What forex trading costs

Four costs apply, and only the first is obvious.

The spread. Every quote has two prices: the lower one you can sell at and the higher one you can buy at. The difference is the spread, and you pay it the moment you open. A position that has not moved at all is not flat — it is behind by the spread.

Commission. Some account types charge a commission per lot in exchange for a tighter spread. Neither structure is automatically cheaper. Compare the total cost, not the headline figure.

Overnight financing, or swap. Hold past the daily rollover time and an amount is credited or debited based on the interest rate difference between the two currencies. It can run either way. It is applied at triple rate on one day each week to cover the weekend. On a position held for weeks, swap can cost more than the spread you paid to open.

Slippage. In fast markets an order can fill at a different price from the one you saw. That is not an error — it is the available price changing between your click and the execution.

Worked example: a EUR/USD trade in both directions

Assume EUR/USD is quoted at 1.0850 / 1.0851. You can sell at 1.0850 and buy at 1.0851, so the spread is 1 pip. Treat that as typical and illustrative rather than fixed; spreads move.

You open a long position of 0.10 lots, which is 10,000 euros of exposure. On EUR/USD, one pip on 0.10 lots is worth about $1.

You buy at 1.0851. At that same instant the price you could sell at is 1.0850, so the position opens about $1 behind. That $1 is the spread, and you have paid it before the market has done anything at all.

Now the move. If EUR/USD falls 20 pips to 1.0830, that is about $20 off your balance, on top of the $1 already paid. A 20-pip move in the other direction is worth the same $20, in the other direction, less the spread.

Had you opened a short position instead, the arithmetic mirrors: a 20-pip rise to 1.0871 takes about $20 off your balance.

Hold the position overnight and a swap charge or credit is applied on top of all of this.

The last figure is the one to remember. Trade 1.00 lots instead of 0.10 and that same 20-pip move is about $200 rather than $20. The market moved exactly the same distance. Position size decided what the move cost you.

Key takeaways

• A forex trade is always two-sided: buying a pair means buying the base currency and selling the quote currency in the same action.
• Retail forex is normally traded as a CFD on margin, so the market’s move applies to the full position size rather than to the deposit you put up.
• Currency prices respond to the gap between released data and what was forecast, which is why the expectation matters as much as the number.
• Every position starts behind by the spread, and a position held overnight accumulates a daily financing charge or credit on top of it.

Frequently asked questions