Forex
Also called FX, Foreign exchange, Currency trading, Forex trading
Forex (foreign exchange, or FX) is the global market where currencies are traded in pairs, such as EUR/USD. People use it to convert money, hedge currency risk and speculate on exchange rates.
Every forex price compares one currency with another. Whether you make or lose money depends on which way that comparison moves and on how big your position is. The two mistakes that cost beginners most: reading a pair backwards and trading a size they never calculated.
How the forex market is set up: no central exchange
Forex has no central exchange and no single official price. Currencies trade over the counter (OTC), which means banks and other large institutions deal with each other directly through dealing networks. Brokers take prices from these sources and quote them to retail traders, so your broker's price can differ slightly from another broker's at the same moment.
Banks, central banks, importers and exporters, funds and individual traders all take part. Trading follows the business day from Asia to Europe to North America, so the market runs around the clock on weekdays. As one region's day hands over to the next, activity and spreads change, so the same pair can behave differently at different hours.
Prices move when demand for one currency changes against the other. The main drivers are interest rate decisions, inflation and jobs data, central bank comments and the general appetite for risk. When a big release is due for either currency in your pair, expect sharper moves and higher trading costs.
Whether you can trade forex as an individual, and through whom, depends on your country's rules. If your broker is not licensed by your own country's regulator, you may have no protection if it fails, so check its licence first.
Reading a forex quote: which currency you buy and sell
Each pair has a base currency (the first one) and a quote currency (the second one). The price tells you how many units of the quote currency one unit of the base currency costs. EUR/USD at 1.1000 means 1 euro costs 1.1000 US dollars. When you buy the pair, you buy the base and sell the quote at the same moment. Selling does the opposite. The picture below shows both directions.
A common misread is assuming that a rising chart means the dollar is rising. On EUR/USD, a rising line means the euro is getting stronger. On USD/JPY, a rising line means the dollar is getting stronger. The picture below puts the two cases side by side.
What a 50-pip move does to your account
A pip is the standard unit of price movement: 0.0001 on most pairs. On yen pairs such as USD/JPY, a pip is 0.01. If you count a yen move with four decimals, you misread it by 100 times. A lot is your trade size. A standard lot is 100,000 units of the base currency, a mini lot is 10,000 and a micro lot is 1,000.
The figures in this example and in the sections below are illustrative. Say you buy EUR/USD at 1.1000 and price rises to 1.1050. The calculation below shows the result for a standard lot and for a micro lot.
If price had fallen 50 pips to 1.0950, the same numbers would be losses. The move is the same either way. Your lot size decides whether it costs you $5 or $500.
The $10 per standard lot only holds when USD is the quote currency, as on EUR/USD or GBP/USD. On USD/JPY, one standard lot moves 100,000 × 0.01 = 1,000 yen per pip. The dollar value of that changes as the USD/JPY price changes. On such pairs, use the pair's own pip value in every formula.
To choose a size, run the calculation backwards: lots = money you are willing to lose ÷ (stop distance in pips × pip value per lot). If you risk $50 with a 50-pip stop on EUR/USD, that gives $50 ÷ (50 × $10) = 0.10 lots. If the result is below your broker's smallest size, skip the trade. Or use a tighter stop, which allows a bigger size for the same money at risk, but only if that stop still makes sense on the chart.
How leverage, spread and swap change what a trade costs
Leverage lets you control a position larger than your deposit. Margin is the part of your deposit the broker sets aside to keep that position open. The rest is your free margin, the money left to open new trades and absorb losses. Say you deposit $2,000 and trade at 1:100 leverage. A $100,000 position then needs $100,000 ÷ 100 = $1,000 of margin. A 1% move against you costs $100,000 × 1% = $1,000, which is half your deposit. The chart below compares that with the same move on a position with no leverage.
The spread is the gap between the bid (the price you sell at) and the ask (the price you buy at). You pay it on every trade. A buy opens at the ask but is valued at the bid, so it starts with a small loss.
The swap is the charge or credit you get for holding a position overnight. It comes from the gap between the interest rates of the two currencies. If you buy the currency with the higher rate, you may receive a credit. If you buy the one with the lower rate, you usually pay. The same pair can pay you in one direction and charge you in the other.
If you plan to hold a trade for days, check the swap for your direction first. Say a 0.10-lot EUR/USD trade is 10 pips ahead: 10 × $1 = $10. If you hold it for six nights at a $2 charge per night, you pay 6 × $2 = $12 in swap. The winning trade closes $2 down before the spread.
Checks before your first forex trade
- Say the trade out loud: "I am buying euros and selling dollars." If it sounds wrong, you have the pair backwards.
- Compare the spread with your stop. On a small stop, the spread can eat most of your edge.
- Check the economic calendar for both currencies.
- Practise on a demo account until you can place a correctly sized order without hesitating.
FAQ
Can I lose more than I deposit trading forex?
Yes. With leverage, a fast move can push your losses past your account balance. Some brokers and regulators offer negative balance protection. Ask your broker whether your account has it before you trade.
What happens to my open trade over the weekend?
It stays open while trading stops. If news breaks while the market is closed, the price can gap at the Monday open. Your stop then fills at the first available price, which can be well past the level you set.
Can I trade gold on a forex account?
Many brokers list gold next to currency pairs as XAU/USD, which is the price of one ounce of gold in US dollars. It reads like a pair, but its pip size, contract size and swap are different. Check its contract details before you work out a size.