Foreign exchange trading – often shortened to forex trading or even just fx trading – is the purchase of one currency while simultaneously selling another.
Currencies trade in pairs, like euro/US dollar (EUR/USD) or pound sterling/US dollar (GBP/USD). The first currency listed is known as the ‘base’, and the second is the ‘variable’. The value of the base currency is always 1.
Unlike trading on the stock market, forex trading does not take place on a central exchange. Instead the foreign exchange market is an OTC (over-the-counter) market. The main forex trading centres are in London, New York, Tokyo, Singapore and Sydney. The worldwide distribution of these trading centres means that forex trading can take place 24-hours a day – the market ‘chases the sun’.
Forex trading is the largest and most liquid market in the world. According to a survey carried out by the Bank for International Settlements (BIS) in 2007, the forex market has a turnover of more than $3 trillion a day.
Who trades forex?
Daily turnover in the forex market comes from two sources: speculation for profit (around 95%) and foreign trade (around 5%). The main market participants in forex trading are banks, but currency speculators, companies and other financial institutions also account for a significant proportion of trading activity.
Most traders focus on the most liquid currency pairs, known as ‘majors’. More than 85% of daily forex trading involves these major currency pairs.
How to trade forex
A relatively straightforward way of gaining access to the forex market is through trading forex CFDs (Contracts for Difference). Forex CFDs let you take advantage of the high volatility seen in the forex market without having to own substantial quantities of the actual currencies.
CFD providers quote a price for a currency pair, and, depending on whether you think the base currency is set to rise or fall against the variable, you buy or sell the base currency. For example, if you thought pound sterling was going to strengthen and that the US dollar was going to weaken, you would buy GBP/USD contracts.
Why trade forex CFDs?
Trading forex CFDs means that you do not have to pay for the full value of the underlying currencies you are trading. Instead you put down a deposit, which, in some cases, means you can trade up to 100 times more than your initial outlay would have bought in actual currency. Because of this remarkably high leverage – and when combined with the liquidity and volatility of the forex market – there is significant potential for making huge profits or losses with forex CFDs in a short space of time, even when there are only very small price movements.
Forex CFDs also enable you to go long (buy) or short (sell) on a currency pair. This means it’s simple to potentially profit from both rising and falling markets.
Leading forex CFD providers offer a wide range of forex CFDs, often with spreads from as little as 1 pip, low deposit requirements and advanced risk management tools.
Remember that CFDs are a leveraged product and can result in losses that exceed your initial deposit. Trading CFDs may not be suitable for everyone, so please ensure that you fully understand the risks involved.