a beginner’s guide to how it works

  • Forex is a global market for exchanging one currency for another.
  • Central banks are also involved in the foreign exchange market, buying and selling currencies in order to make the value of their original currency go up or down.
  • The forex markets offer investors 24/7 liquidity and trading, but they are very volatile.
  • Visit Insider’s Investment Reference Library for more stories.

If you’ve already started your investing journey, the stock market is a familiar place. But if you are looking to expand your portfolio and see how you can strengthen your portfolio, there is foreign exchange or forex.

Forex consists of exchanging one currency for another. For example, a person could exchange the US dollar for the Japanese yen. Forex offers depths

liquidity
and 24/7 trading, so investors have plenty of opportunities to get involved.

Understanding Forex

The forex market is a global electronic network of banks, brokers, hedge funds, and other traders. This market is where one currency is traded for another for the purpose of making a profit.

Central banks are also involved in the foreign exchange market, where they are responsible for maintaining the value of their country’s currency. This value is represented as the exchange rate by which it will trade in the open market.

Market participants can trade in the spot market and also buy and sell derivatives. As a result, they can trade futures contracts, futures contracts and swaps.

Investors trade forex in pairs, which list the base currency first and the quote currency second. For example, if someone trades JPY / USD, the Japanese Yen is the base currency and the US dollar is the quote currency.

Forex Pricing: Base Currency and Quote Example Using JPY and USD

Every forex trade involves a pair of currencies.

Alyssa Powell / Insider


Investors interested in forex have the option of trading several different currency pairs: major pairs, minor pairs, exotic pairs and regional pairs.

  • The major pairs involve the US dollar and include USD / JPY, EUR / USD, USD / CHF, and EUR / USD. These four currency pairs account for 80% – a large majority – of forex trading, according to figures provided by IG.
  • The minor pairs, which is made up of other major currencies including GBP / JPY, EUR / GBP, and EUR / CHF.
  • There are exotic pairs, which involve a primary currency combined with a secondary currency, such as EUR / CZK, USD / PLN, and GBP / MXN.
  • Then there is regional pairs, which are named after different geographic regions, for example Australasia or Scandinavia. AUD / SGD, EUR / NOK and AUD / NZD all count as regional pairs.

By far the most traded currency in the world is the US dollar; it records more than $ 5,000 billion in transaction volume per day, according to The figures of the Bank for International Settlements (BIS). BIS data also reveals that the euro is not that close, with more than $ 2.1 trillion in daily trading volume, and the Japanese yen and British pound are the third and fourth largest currencies in terms of average daily trade volume, at $ 1.1 trillion and $ 844 billion, respectively.

The foreign exchange market

This global market has two levels: the interbank market and the over-the-counter (OTC) market. The interbank market involves institutions that exchange currencies with each other and have the ability to set exchange rates due to the scale of their transactions.

The over-the-counter market is different in that it involves transactions that are done electronically instead of going through a third party like a broker or a stock exchange.

How forex trading works

Forex trading involves trading currency pairs for the purpose of hedging or speculating. For retail investors, the process of forex trading involves opening a brokerage account, funding it, and then trading.

Once set up, if an investor thinks the US dollar is going to rise against the Japanese yen, they can buy the US dollar and sell the yen. However, if that same investor thinks the Euro is going to fall against the US Dollar, they can sell EUR / USD by opening a sell position for a lot of that pair.

Either way, if their bet is correct, they will make a profit. However, if their prediction is not correct, they will suffer a loss.

Investors trade currencies in lots, which are simply the number of units of those currencies. There are standard, mini, micro and nano bundles, which consist of 100,000, 10,000, 1,000 and 100 currency units respectively.

Traders often aim to capitalize on small fluctuations in exchange rates, which are measured in pips, which represent one hundredth of 1 percentage point.

Hedge funds also use brokers. “[They] typically use institutional brokers, but they often also use the same brokers as retail investors, although they almost always trade volume discounts / better terms, ”says Tim Enneking, managing director of the hedge fund manager. Digital capital management.

The pros and cons of forex trading

Forex offers a number of benefits including high liquidity, 24 hour access, and access to leverage, which can help generate higher returns. In addition, some forex brokers promote themselves as offering commission-free transactions.

Another major attraction of forex trading is the small amount of capital that a person needs to get started. “You can easily trade using leverage, which means you need relatively little capital to be able to trade currencies,” says Julius de Kempenaer, senior technical analyst at StockCharts.com.

“This is not a problem for day trading or scalping as the forex market is much less regulated than the stock / bond market.” Scalping involves making transactions that take advantage of small changes in the value of currency pairs.

But there are also downsides, like leverage, which can be a double-edged sword as it can magnify both gains and losses. Additionally, Enneking notes that the forex market has low volatility. “Without leverage, it’s a tough market to make real money,” Enneking says.

Retail traders can face substantial risk due to the easy access to leverage and the lack of understanding of how it works.

The financial report

The forex market offers many opportunities for traders, allowing them significant access to leverage, the ability to trade 24/7, and the ability to start with a small down payment. There are many online brokers that they can use, providing them with a plethora of options.

However, they should keep in mind that while there is potential for gains, there are also significant risks. For starters, leverage can magnify losses, and many retail traders who wish to participate will find themselves competing with professional traders working for financial institutions.

“Newbies have their work cut out for them,” says Enneking. “There is a plethora of long-time, highly skilled and very knowledgeable players in the space. You have a long learning curve to climb to feel comfortable and successful in the business.”

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