What’s so special about the Forex market? Many people are curious about Forex trading, but they’re unsure how Forex works, how much money is in Forex and whether it can help them reach their financial goals.
If you can relate, keep reading for a crash course in Forex trading. We’ll clear up some of the mysteries, so you can decide if investing in the Forex market is a fit for you. There’s a lot to unpack, but that’s one of the best parts of Forex trading — there’s always more to learn, and each day brings more chances to hone your strategy. There’s no better time to get started!
What is Forex?
“Forex” is shorthand for foreign exchange. It’s a market where people exchange one country’s currency for another country’s currency. You’ll sometimes hear it called the “cash market” or “spot market,” because trades occur on the spot, at whatever the price is at the moment the transaction occurs.
The Forex market was established in 1971. Around this time, most of the world’s large industrialized nations began dropping the gold standard and allowing their currencies to float freely, with minimal government intervention. But it wasn’t until the late 1990s that the Forex market really opened to individual traders. And since then, it has skyrocketed in popularity.
Unlike the stock market, the Forex doesn’t have a centralized, physical location. Forex trading takes place on the “interbank,” which is a network of about 4,500 world banks and retail brokers. These players monitor the constantly changing prices of currencies and execute transactions for their clients.
When it comes to making the trades, the action happens on electronic platforms and via phone between banks and other market participants. Trading happens continuously around the globe, stopping only for weekends and holidays.
To trade on the Forex market, you’ll need to create an account with a currency broker. This is where your profits will be deposited and your losses will be deducted. These deposits and deductions are made instantly upon exiting a position.
How much money is in Forex?
As you’ve probably guessed, buying and selling currency is big business. The Forex market is the largest financial market in the world, with more than $5 trillion in trading each day. That’s about 25 times the volume of global equities being traded each day.
Why is the Forex market so large? First, the market is active nearly nonstop. When one region’s market closes, another opens. Traders in Australia can trade in North American markets, and vice versa.
Second, currency trading is in high demand by central banks, international trade and global businesses. Often, a country’s central bank will try to shore up its national currency by trading it on the open market. Meanwhile, global corporations use Forex trading to hedge their risks of operating in foreign markets.
What kinds of currencies are traded on the Forex?
The Forex market includes currencies from every country in the world, but most of the volume swings toward a few key players, called “major currencies.”
- USD: United States / Dollar
- EUR: Euro Zone / Euro
- JPY: Japan / Yen
- GBP: United Kingdom / Pound
- CAD: Canada / Dollar
- CHF: Switzerland / Franc
- AUD: Australia / Dollar
Currencies are always traded in pairs, and “major currency pairs” refers to those that are most commonly traded together:
- EUR/USD: Euro Zone / United States
- USD/JPY: United States / Japan
- GBP/USD: United Kingdom / United States
- USD/CHF: United States / Switzerland
- USD/CAD: United States / Canada
- AUD/USD: Australia / United States
Of course, this isn’t an exhaustive list of currencies traded on the Forex. There are many other combinations, including “exotic pairs,” which incorporate the currency of an emerging economy such as South Africa or Thailand.
In every trade, you are betting on one currency over another. If you believe the Swiss franc will appreciate against the U.S. dollar, you’ll sell U.S. dollars and buy francs. This position is called “selling short.” If you believe the opposite, you’ll buy U.S. dollars and sell Swiss francs, which is called “buying long.”
How can Forex traders make a profit?
Making a profit on the Forex comes down to a quirky-sounding word: pip. In fact, pip is an acronym for “price interest point.”
The pip system monitors price movements in the market. Pips are usually measured in decimals. Depending on the pair being traded, pips are usually the last number of the decimal in the price evaluation. A trader’s financial reward is measured in pips, and those pips are converted into dollars.
To understand how this breaks down, you need to know about currency lots. There are three main types of lots you can trade on Forex:
- A micro lot is approximately $1,000 worth of a foreign currency
- A mini lot is approximately $10,000 worth of a foreign currency
- A standard lot is approximately $100,000 worth of a foreign currency
Each type of lot creates a different payout. A micro lot pays about $0.10 per pip captured, a mini lot pays about $1, and a standard lot pays about $10. As you might expect, greater risk comes with greater potential reward.
What are the advantages of the Forex trading market?
The Forex market offers several key advantages:
- Liquidity: Many high-risk, high-return investments are difficult to sell at will. But with Forex trading, you can open or close a position whenever you want during market hours. Forex traders don’t have to worry about being “stuck” in a position due to a lack of market interest.
- Access: Since the Forex market is open 24 hours a day from about 5:00 pm ET Sunday to about 5:00 pm ET Friday, you can react to news when it breaks rather than having to wait for the opening bell. That means you can take positions before the news details are fully factored into the exchange rates. There are Forex dealers in every time zone and in every major market center willing to continually quote buy and sell prices.
- Two-way market: Every position involves the selling of one currency and the purchase of another, so there’s always a potential for profit exists. Forex trading offers the opportunity to capture pips from both rising and falling currency values.
- Leverage: Compared to trading stocks and other markets, Forex trading provides excellent leverage of 1% to 4% of the margin value. For example, a $2,000 deposit in your margin account can control $100,000 worth of currency, which means you can control each lot for one to two cents on the dollar.
- Less “slippage”: In fast-moving markets like stocks and commodities, you’ll often experience “slippage” in the value of your trade. But because the Forex market is so liquid, most trades can be executed at the current market price. In fact, currency broker software can show your exact entering price just before you execute the trade, so you have the option to avoid or accept any slippage.
As you can tell, the Forex market really is special. It’s the largest trading market in the world —and one of the most complex. But with solid strategies and proven resources, you’ll be well on your way to discovering dynamic new opportunities.