What is forex trading?

It’s the speculative purchase of a currency in the hope its value will increase

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Exchanging one currency for another is a form of “forex” (foreign currency exchange), and if you’ve ever traveled internationally, you’ve probably done this. But forex trading is the exchange of foreign currencies for the purposes of making a profit, or as an investment strategy for institutions to protect against fluctuating markets. Forex trading is a $5 trillion market, according to Nasdaq, making it one of the largest and most liquid markets in the world.

While forex may seem complicated, we’ll break down the basics of forex trading, including how it works, terms you need to know and how to start trading yourself. Plus, we’ll help you learn about forex trading scams to keep yourself (and your money) protected.

Key insights

  • Forex trading is an active exchange of currency pairs, such as U.S. dollars with euros.
  • Forex trading happens through over-the-counter exchanges, not through a centralized market exchange.
  • Forex trading is speculative and may include the use of leverage or margin, borrowing funds to trade larger amounts.
  • Forex scams are very prevalent, so only trade forex through a licensed and registered broker.

Forex trading for beginners

“Forex trading entails purchasing or selling a foreign currency for an economic profit,” said Frank Murillo, managing director at Snowden Lane Partners in Miami.

“While this may sound like the activities of day traders on Wall Street, it’s not uncommon for everyday folks to engage in this as well. For example, if you were taking a trip to Europe over the past year, it would have been a good time to purchase euros as it’s almost reached parity to the U.S. dollar (a 1-to-1 exchange).”

Forex trading is the act of exchanging one currency for another through an online broker or investing app in the hopes of making a profit. When you trade currencies, you are essentially converting one currency for another. And because the exchange rate of currencies fluctuates constantly, the prices of currency conversion change as well.

These trades happen through over-the-counter (OTC) trades on foreign exchange markets — meaning the transactions happen through a network of global banks instead of through a centralized marketplace.

Forex trades happen in currency pairs, such as U.S. dollars and euros. These pairs are expressed with each currency’s three-letter code. For example, EUR/USD is the code for exchanging euros and U.S. dollars.

The goal of forex trading is to make a profit. If you think that euros will rise in value, then you can trade U.S. dollars for euros. If you are correct, you will make money. In this way, forex trading is speculative — traders speculate what the value of a currency will be in the future.

Forex trading hours

Forex is one of the only markets that is open around the clock. Since forex trading is global, markets are open 24 hours a day, five days a week. It is not open on weekends.

» MORE: How to buy stock

Forex terms

Before you start trading Forex, it’s important to familiarize yourself with the language of foreign exchange.

  • Currency pair: The two currencies that are to be exchanged. All forex trading happens in currency pairs.
  • Forex account: An account (typically through an online broker) that allows you to access foreign exchange markets. This is where you deposit your native currency and begin trading forex.
  • Ask: The price that you’re willing to pay to purchase a currency.
  • Bid: The price at which you’re willing to sell a currency.
  • Spread: The difference between the ask and bid prices.
  • Pip: The smallest unit of measurement that calculates a price change in a currency pair. Most foreign currency exchanges allow up to four decimal points, so one pip would be 0.0001.
  • Lot: A predetermined amount of currency that can be traded. There are several different lot sizes, depending on what you are trading. The standard lot size is 100,000 units of currency, and there are smaller sizes as well, including mini (10,000 units) and micro (1,000 units).
  • Leverage: Since lot sizes are so large, many traders utilize borrowed funds to execute trades. This is known as leverage.
  • Margin: The amount of funds used by traders when utilizing leverage. This means they need to use a certain amount of personal funds when borrowing.

How to trade forex

To start trading forex, you’ll need to create an account with a broker that offers access to forex markets. Once the account is created, you’ll deposit funds and can explore the forex trading tools your broker offers.

There are three main ways to trade forex: the spot market, the forward market and the futures market. While the spot market offers straightforward exchanges, the foward and futures markets let you trade with leverage, making them highly speculative.

Here’s how each works:

The spot market
The spot market is the most popular forex market, and it represents the real-time price of each currency. This is where currencies are exchanged in pairs, and the prices are determined by supply and demand.

The spot market allows traders to speculate on the prices between currency pairs, such as the EUR/USD pair. If a trader anticipates the EUR rising in price and the USD dropping in price, they would trade U.S. dollars for euros and then sell them back after the price changes.

The forward market
The forward market allows traders to buy or sell forward contracts. A forward contract is an agreement to purchase a currency on a future date at a predetermined price. This contract is a binding private agreement between two parties.
The futures market
The futures market is similar to the forward market, but instead of a private contract agreement, it takes place on a public exchange, such as the Chicago Mercantile Exchange (CME). A futures contract is an agreement between parties to buy or sell currency on a future date for a predetermined price. These contracts can be traded on the open market before expiry.

Is forex trading profitable?

Forex trading allows you to speculate on the future price of a given currency, and if you are right, you can make a profit. But if you are wrong, you can easily lose money.

Forex trading is speculative and requires diligent research and an understanding of foreign currency markets to be successful. There are a number of factors that can affect a currency’s price, including:

  • Economic environment
  • Political environment
  • Interest rates
  • Sentiment
  • Supply and demand

If you are unfamiliar with those factors for a given currency, you should avoid forex trading.

“Anyone who does not understand the movements of currencies and is not willing to accept the risks involved [should not trade it],” said Murillo. “Currency movements can be incomprehensible at times, and nobody gets it right 100% of the time.”

But if you have intimate knowledge of these factors and the currency markets, you may be able to make a profit speculating on foreign currency prices.

» MORE: What is a good investment?

Forex trading scams

Unfortunately, forex trading attracts a lot of scams, which are designed to steal money from forex traders. There are several ways forex scammers attempt to do this, including:

  • Fake broker websites
  • Imitating big-name forex traders
  • Selling fake forex products

Most of these scams attempt to collect your personal information or to convince you to send money to someone in hopes of a bigger return. Here are some signs to watch out for:

  • Broker is not registered or licensed by local authorities
  • Broker or person that promises huge returns
  • A social media account is asking for personal information
  • Someone is directly asking for you to send them money

If you are unsure about investing in forex, or if someone is directly asking you for money or personal information, do not engage. Instead, focus on finding a reputable licensed broker that provides service in your country.

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What is the most valuable currency?

The Kuwaiti dinar (KWD) is the most valuable currency in the world. Since its introduction in 1960, it has consistently traded with the highest value among world currencies. Kuwait’s stable economy, backed by strong oil production as well as a tax-free system, keeps its currency at the top of the list. One KWD is currently worth over $3 USD.

Why trade forex?

Forex trading is a speculative activity designed to earn money on the change in price of a specific currency pair. Forex traders attempt to profit by purchasing contracts or trading spot prices of specific currencies.

How much money do you need to trade forex?

Forex trading happens in “lots,” which start at $1,000 for a micro lot. If you are trading spot, you would need at least $1,000 to get started. But many brokers offer leveraged trading, allowing you to use less of your own money and borrow the difference. This allows traders to start with $100 (or less) at some brokers.

Is forex trading risky?

Yes. Forex trading is a speculative activity that requires a deep knowledge of foreign currency markets. If you don’t know what you are doing, you can quickly lose money. And since many forex trades involve the use of leverage, this can quickly amplify your losses.

Is forex trading legit?

Yes, forex trading is legit and is one of the most liquid markets in the world. But forex trading is also fraught with scams, so it’s important to only work with reputable brokers that are licensed and regulated in your country.

Bottom line

Forex trading is a popular activity among institutions and active traders, but it’s not a long-term investment strategy. Forex is a speculative activity, so before you jump in, it’s important to understand the foreign currency market, what factors affect prices and how the different methods of trading work.

Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
  1. Nasdaq, “ Forex Market Overview .” Accessed Sept. 30, 2023.
  2. CME Group, “ The World’s Leading Derivatives Marketplace .” Accessed Sept. 30, 2023.
  3. Commodity Futures Trading Commission, “ Advisory on Foreign Currency .” Accessed Sept. 30, 2023.
  4. Bloomberg, “ Kuwaiti Dinar Spot .” Accessed Sept. 30, 2023.
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