Forex Trading Explained

The term Forex Trading refers to trading on the foreign exchange or currency market, where one currency is exchanged for another. It is one of the largest and most liquid financial markets in the world. Some market participants, such as multinational corporations, exchange currencies for purely practical reasons—such as to pay salaries or cover expenses in countries where they operate without actually selling products there. However, a significant portion of trading is carried out by speculators who aim to profit from exchange rate fluctuations—similar to investors who bet on stock price movements. These forex traders take advantage of even the smallest changes in exchange rates.

The foreign exchange market is largely free from “insider information,” which can be an issue in other markets. Price movements are typically driven by real capital flows and expectations about global macroeconomic developments. Relevant information and economic data are usually published publicly and simultaneously worldwide, meaning all market participants theoretically have access to the same information at the same time.

Currencies are traded in pairs, with each currency pair representing a unique trading instrument. The notation takes the form XXX/YYY, where YYY corresponds to the international ISO 4217 code of the currency in which the price of one unit of currency XXX is quoted. For example, EUR/USD denotes the exchange rate from euros to US dollars, such as 1 euro = 1.2045 US dollars.

Unlike exchange-based markets such as stock or futures markets, forex trading is decentralized and operates as an interbank (OTC – Over the Counter) market. There is no central exchange for trading a particular currency pair. The forex market is open around the clock—five days a week—allowing participants to trade continuously worldwide: when the European trading session ends, the Asian or American session begins, ensuring a market is always open. This enables traders to react to current news in real-time without being dependent on stock exchange opening hours.

According to the triennial report by the Bank for International Settlements (BIS), the average daily trading volume in the global forex market in April 2019 was USD 6.6 trillion.

As in any market, there is a bid-ask spread in the forex market—the difference between the buying price (ask) and the selling price (bid). For major currency pairs, this spread is usually very narrow—typically just 1 to 2 pips. A pip refers to the fourth decimal place of an exchange rate. For a EUR/USD rate of 1.4238, one pip would be 0.0001—the “8” at the end. A typical example of a bid/ask price might be 1.4238/1.4239.

What is Forex?

Many people ask themselves: What is Forex? Today, “Forex” is the most common abbreviation for “Foreign Exchange”, i.e. the trading of foreign exchange – the price of one currency in relation to another. By definition, all forex rates refer to a currency pair, as two currencies are always being compared to each other.

The term “forex” is often used interchangeably with “FX”. Both abbreviations mean the same thing: the foreign exchange market. In the USA and in the professional trading environment – for example at banks or brokers – the term “FX” is usually preferred, while “Forex” is more common in the British-speaking world and in the retail sector (i.e. among private traders). The more general word “currency” is also used, for example in statements such as: “I trade currencies” or “Something has happened in the currency market”.

“Forex trading” therefore refers to the trading of currencies on the foreign exchange market. It is the exchange of one monetary value for another that is considered to be of equal value. The term “trade” stands for a transaction in which two parties are willing to exchange their respective currency unit at a certain rate. This rate – also known as the exchange rate – is the price at which both sides are willing to carry out the exchange.

Although it is correct to speak of the “price” of a currency, the term “rate” is more common in the forex market. Forex trading is the only financial market where the word “rate” is consistently used instead of “price”. There are historical reasons for this: The term “rate” was already used in the Middle Ages for customs duties or levies in which a certain ratio – a share – was applied. When exchanging currencies, a ratio between two values is also calculated. The Latin “pro rata” (“in proportion”) expresses this aptly. The English word “rate” (as in “exchange rate”) comes from the Latin “rata”.

What is exchanged in Forex trading?

Since forex always refers to two currencies, each with its own face value, forex trading can be as simple as exchanging 100 British pounds for $165 at an airport kiosk. The exchange rate in this case is $1.65 per GBP.

Why isn’t this rate quoted as £0.6061 per USD instead? This would be mathematically correct – it is only the reciprocal of the original exchange rate (1 ÷ 1.65). The answer lies in historical conventions: In the past, the price of other currencies was expressed in British pounds, i.e. according to what they cost in pounds. The pound sterling was the world’s leading reference currency for centuries – until shortly after the Second World War. All other currencies were valued against the pound.

After World War II, the U.S. dollar became the new reserve currency that most other currencies are based on. Since then, it has become common to express exchange rates in the form: “How many units of a foreign currency do I get for one US dollar?”

In general, any currency that has not been issued by your home government is considered “foreign”. The intuitive approach of many people – such as tourists or importers – is to ask, “How many units of foreign currency do I get for a fixed amount of my local currency?” Nevertheless, in most cases today, the US dollar is used as the basis for currency quotations. In many currency pairs, the dollar comes first – but not all. The first mentioned currency in a currency pair is the base currency, while the second is the so-called quote currency.
When a currency is mentioned first, it means that the rate indicates the price of the second currency that you get for a unit of the first currency. When the European Monetary Union introduced the euro, it was deliberately decided to put it first in pairs such as EUR/USD or EUR/JPY in order to position it as the more important of the two currencies.

Basically, if the exchange rate rises (for example, GBP/USD from 1.6000 to 1.6500), then the base currency – in this case the pound – becomes stronger, while the quote currency – in this case the dollar – becomes weaker. In concrete terms, this means that you now get more US dollars for one pound. In this presentation, a higher rate always means an appreciation of the base currency against the quote currency. So it is correct to say: “The pound has risen from 1.6000 to 1.6500”, or also: “The pound now costs 1.6500 USD.”
Although financial journalists often write the currency symbol – such as $ – in front of the price, professional analysts and brokers often refrain from specifying a symbol.

For example, if the EUR/USD exchange rate rises from 1.3200 to 1.3900, this means that the euro has strengthened against the dollar – i.e. has become more expensive in dollar terms. For beginners, it can be helpful to think of the symbol of the base currency when quoting prices in order to understand the representation more easily. So you can imagine the price quotation as “1.3200 to 1.3900 dollars per euro”.

What is Forex Trading exactly?

If you go to the kiosk at the airport to exchange your home currency for another, you’re not really trading – you’re a so-called price taker. The sign on the kiosk shows you the exchange rate that applies. You can accept it or not – you can’t negotiate.

This is not real forex trading. Trading means that you haggle with a counterparty for a price – back and forth until you agree on a course that suits both of you. Maybe you’re willing to buy something that is worth more to you personally than to others, or you want to sell something that others value less than you do. Once you’ve agreed on a rate, a contract is created – whether verbal or written – that specifies that you will deliver your currency and the other side will transfer theirs to you in return, at a specific time and place.
In reality, the whole thing usually runs through bank accounts: your currency is transferred from an account in your country to the account of the other party in the respective country – no cash, no suitcases full of money.

When trading Forex, however, you should always keep your long-term goals in mind. On many trading websites, you will find forums where you can exchange ideas with other traders – about strategies, market developments and your personal goals. These conversations can help you find your way and move forward.

And very important: Expect to make losses from time to time – even if you stick to recommended trading strategies. Losses are part of trading. The decisive factor is how you deal with it: stay calm, learn from it and develop your strategy further. In this way, you will become more confident in dealing with the market step by step.

If you like, I will be happy to help you with a simple overview of how to set up your first trade, or show you typical beginner’s mistakes that you should avoid.