Forex (also known as FX) is simply the shortened name for ‘foreign exchange’. And foreign exchange is the trading of one currency for another.
A forex trader speculates on the price movements of one currency against another with the aim of making a profit.
Key forex facts
It’s huge
Forex is the world’s most traded market with over $6 trillion* being traded every day. To put it in perspective, the daily average volume for stock market trading is only $22.4 billion (4% of forex’s size)**
You’ve probably already done it
When you holiday in another country, you have to exchange your money into the foreign currency to spend money there.
They come in pairs
You’re always trading one currency against another e.g. the British pound against the US dollar (GBP/USD).
There are always opportunities
Forex is an exceptionally liquid and volatile market and it’s reacting all the time. This makes it especially attractive to day traders looking for short-term wins.
There’s no exchange
Unlike shares which use exchanges such as the New York Stock Exchange or London Stock Exchange, forex is traded by a global network of banks.
It never sleeps
You can trade forex 24 hours a day, 5 days a week. This is because the time zones of the four trading centres (London, New York, Sydney and Tokyo) overlap with each other. So when one closes, another opens.
*April 2016 average daily volume from BIS 2016 Triennial FX Report
**April 2016 average daily volume from Cboe Global Markets
How forex trading works
Before we dig into the details, let’s take a look at a simplified forex trade
Trading EUR/USD
You believe that the value of the euro will rise against the US dollar because the EU reported strong economic growth.
So you buy EUR/USD – meaning you’re buying euros while selling the US dollar.
Scenario 1 – you are correct
Your analysis was spot on and the euro rises against the dollar.
Your position increases in value and you decide to close your trade and take your profit.
Scenario 2 – you are incorrect
The markets don’t react the way you anticipated, and the euro falls against the dollar.
Your position decreases in value and you decide to close your trade and take your loss.
Forex currency pairs
Forex is always traded in currency pairs e.g. AUD/USD. This is because a currency cannot be speculated against itself; its value is always in relation to another currency’s.
But why does AUD/USD look like the way it does?
Every currency in forex trading is signified by three letters. These are known as the ISO 4217 Currency Codes.
The first two letters denote the country. The third represents the currency name.
- AUD = Australia dollar
- USD = United States dollar
Forex currency pair nicknames
As you become immersed in the world of forex, the currency pairs are often referred to by their nicknames. Here are just a few:
- GBP/USD – Cable
- EUR/CHF – Swissy
- EUR/USD – Fiber
- EUR/GBP – Chunnel
- NZD/USD – Kiwi
Types of currency pairs
Pairs are categorised into three types: majors, minors, and exotics.
Major pairs
As the name suggests, major pairs are the most popular traded currency pairs. They account for around 85% of the total FX trading volume and are represented by some of the world’s largest economies.
Over a ¼ of all forex trades are EUR/USD. Other major pairs include:
- EUR/USD – the euro vs the US dollar
- USD/JPY – the US dollar vs the Japanese yen
- GBP/USD – British pound sterling vs the US dollar
- AUD/USD – the Australian dollar vs the US dollar
- USD/CHF – the US dollar vs the Swiss franc
- USD/CAD – the US dollar vs the Canadian dollar
As they are so regularly traded, you’ll typically find the major pairs to have the tightest spreads. This makes them less costly to trade than other forex pairs.
What is the spread?
The spread is the difference between a market's buy and sell price. The tighter the spread, the easier it is to make a profit.
As we do not charge commissions, the spread is how we as the forex provider make money from the trade.
In the same way a high-street retailer adds a little extra to the price when it buys stock from a wholesaler, the spread is how most forex providers compensate themselves for the service they provide.
Minor pairs
Minor pairs are currency pairs that don’t include the US dollar. They are also known are cross currencies.
Examples include:
- EUR/GBP – the euro vs British pound sterling
- EUR/CHF – the euro vs the Swiss franc
- GBP/AUD – British pound sterling vs the Australian dollar
- GBP/JPY – British pound sterling vs the Japanese yen
- CAD/JPY – the Canadian dollar vs Japanese yen
- CHF/JPY – the Swiss franc vs the Japanese yen
- EUR/NZD – the euro vs the New Zealand dollar
As they are less traded than the major pairs (meaning the market is not as liquid), the spreads are usually wider than the major currency pairs.
Exotics
Exotic pairs consist of a major currency and a much less-traded one e.g. the US dollar vs the Brazilian real (USD/BRL).
Many of the smaller currencies are from developing countries or small nations with strong economies. They often come with the largest spreads as they are the least traded type of pair.
Examples include:
- USD/MXN – the US dollar vs the Mexican peso
- USD/THB – the US Dollar vs the Thai Baht
- GBP/PLN – British pound sterling vs the Polish zloty
- GBP/SEK – British pound sterling vs the Swedish krona
- EUR/RON – the euro vs the Romanian leu
- EUR/RUB – the euro vs the Russian rouble
Exotics are more suitable for experienced traders. Due to the economic and political instability of some nations, they present a greater risk (or potentially greater rewards) than the other pair types.
You’ve just scratched the surface of forex. Find out more on why to trade Forex in our next section.
