Discover the world of Forex trading
A beginner’s guide to everything you need to know to start trading Forex.
Trading is risky.
Contents
What is forex trading?
Definition of Forex
Forex trading, also known as foreign exchange or FX trading, is the process of buying and selling currencies in the global market. It’s the largest and most liquid financial market in the world, where currencies are traded 24 hours a day, five days a week.
- Traders exchange one currency for another at an agreed-upon price.
- The Forex market operates electronically, allowing traders to trade from anywhere in the world, 24 hours a day, 5 days a week.
- Currency pairs are quoted in terms of one currency relative to another, with the first currency being the base and the second being the quote or counter currency.
Why trade forex?
Forex trading offers a range of opportunities for all traders, from beginners to experienced professionals, and the Forex market plays a crucial role in the global economy and financial markets.
Liquidity
With a daily trading volume of over $6 trillion, the Forex market boasts immense liquidity, meaning that traders can buy and sell currencies easily and often without significant price movements.
Accessibility
Forex trading is accessible to any kind of trader, with trading from a few dollars to tens of thousands. The availability of online trading platforms means that anyone with an internet connection can participate in Forex trading.
Volatility
The Forex market is known for its volatility, meaning rapid and significant price fluctuations that happen over short periods. High volatility offers opportunities for profit, but it also entails increased risk. Traders should use effective risk management strategies to navigate volatile market conditions successfully.
Contracts for Difference (CFDs) and Leverage
Forex CFD trading offers leverage, allowing traders to control large positions with a relatively small amount of capital. CFDs also provide an opportunity to go long (buy) or go short (sell) meaning you could benefit from both increases and decreases in market prices. Risk management is crucial for trading with leverage as it can amplify both profits and losses.
Availability
Unlike stock exchanges that operate during specific hours, the Forex market operates 24 hours a day, five days a week. This continuous availability allows traders to react to global economic events and news developments as they happen, without having to wait for markets to open.
Understanding currency pairs
All Forex trades involve the simultaneous buying and selling of two currencies. The combination of the currency to be bought and the currency to be sold is called a currency pair.
The currency pair is made up of a base currency and a quote currency.
Alpari offers hundreds of combinations of currency pairs to trade including the majors which are the most popular traded pairs in the Forex market.
The diagram looks at the most traded currency pair (EUR/USD) in the Forex market and highlights its essential components
For most currency pairs, a pip is the fourth decimal place, except for the Japanese yen, and a few other exceptions, where a pip is the second decimal place.
In the Forex market, trades in currencies are often worth millions, so small bid-ask price differences (meaning several pips) can soon add up to a significant profit. Of course, such large trading volumes mean a small spread can also equate to significant losses.
Trading Forex comes with risks and traders need to implement effective risk management tools and techniques to mitigate and minimise losses.
Components of a currency pair
Base currency
The base currency is the first currency listed in a currency pair (on the left) and serves as the basis for the exchange rate. It’s the currency being bought or sold.
In the EUR/USD currency pair, the euro (EUR) is the base currency. When quoting exchange rates, the base currency's value is always equal to one unit. In other words, it represents the amount of the quote currency needed to buy one unit of the base currency.
Quote currency
The quote currency is the second currency listed in a currency pair (on the right) and is the currency in which the exchange rate is quoted. It’s sometimes called the "counter currency" or "secondary currency."
In the EUR/USD currency pair, the US dollar (USD) is the quote currency. The exchange rate indicates how much of the quote currency is needed to exchange for one unit of the base currency.
Bid price
The bid price is the value at which a trader is prepared to sell a currency. This price is usually to the left of the quote and often in red.
Traders who want to sell a currency, aim to do so at the highest possible bid price to maximise their profit.
The bid price is given in real time and is constantly updating as it is a live market.
Ask price
The ask price is the value at which a trader accepts to buy a currency or is the lowest price a seller is willing to accept. This is usually to the right of the quote and in blue. Traders who want to buy a currency pair aim to do so at the lowest possible ask price to minimise their cost.
The ask price is given in real time and is constantly changing as it is a live market.
Understanding spread and pips in Forex
Spread and pips are two important concepts that traders need to understand as they directly impact the cost of trading and potential profits or losses.
Spread
The difference between the ask price and the bid price in a currency pair is called the spread and is the cost of trading.
The narrower the spread, the cheaper the costs, and, therefore, more favourable for the trader. The wider the spread, the more expensive it is.
For example, if EUR/USD is trading with an ask price of 1.1918 and a bid price of 1.1916, then the spread will be the ask price minus the bid price. In this case, 0.0002.
Pip
A point in percentage – or pip for short – is a measure of the change in value of a currency pair in the Forex market.
It’s the smallest possible move that a currency price can change which is the equivalent of a ‘point’ of movement.
Pips are typically measured to the fourth decimal place for most currency pairs, except for those involving the Japanese yen, which are measured to the second decimal place.
Long and short positions in Forex
Long position (Buying)
A long position, or ‘going long’, in the forex market means buying a currency pair with the expectation that its exchange rate will increase over time.
Traders take a long position when they think the base currency will strengthen against the quote currency. (The price will increase.)
Profits are made in a long position when the exchange rate of the currency pair rises. Traders aim to buy the currency pair at a lower price and sell it at a higher price.
Long positions are typically considered bullish, as traders are optimistic about the future performance of the base currency relative to the quote currency.
If you wanted to open a long position on the euro, you'd purchase EUR/USD at an exchange rate of 1.1918. You’ll then hold your position with the anticipation of selling it later at a higher exchange rate to realise a profit.
Short position (Selling)
A short position, or ‘going short’ or ‘shorting’, in Forex means selling a currency pair with the expectation that its exchange rate will decrease over time.
Traders take a short position when they believe that the base currency will weaken against the quote currency. (The price will decrease.)
Profits are made in a short position when the exchange rate of the currency pair falls. Traders aim to sell the currency pair at a higher price and buy it back at a lower price.
Short positions are typically considered bearish, as traders are pessimistic about the future performance of the base currency relative to the quote currency.
A short position for euro would be if you think the euro will weaken against the dollar. You’d sell EUR/USD at an exchange rate of 1.1916 and anticipate buying it back later at a lower exchange rate, to realise a profit.
The different categories of currency pairs
In the forex market, currency pairs are categorised into different types based on their liquidity, trading volume, and the strength of the economies associated with the currencies. The main types of currency pairs include major pairs, minor pairs (cross currency pairs), and exotic pairs.
Major currency pairs consist of the most actively traded currencies globally and involve pairs where the US dollar (USD) is one of the currencies. These pairs typically have high liquidity, tight spreads, and are heavily influenced by economic and geopolitical developments in the countries involved.
The traditional major currency pairs are:
- EUR/USD (Euro/US dollar)
- GBP/USD (British pound/US dollar)
- USD/JPY (US dollar/Japanese yen)
- USD/CHF (US dollar/Swiss franc)
The commodity major currency pairs are:
- AUD/USD (Australian dollar/US dollar)
- USD/CAD (US dollar/Canadian dollar)
- NZD/USD (New Zealand dollar/US dollar)
Major currency pairs are favoured by traders due to their liquidity and relatively low transaction costs.
Minor currency pairs, also known as cross currency pairs or crosses, don't include the US dollar. Instead, they involve two major currencies other than the USD. These pairs are less liquid than major pairs and may have wider spreads. However, they still offer trading opportunities for traders looking to diversify their portfolios or capitalise on specific currency movements.
Examples of minor currency pairs include:
- EUR/GBP (Euro/British pound)
- EUR/JPY (Euro/Japanese yen)
- EUR/CHF (Euro/Swiss franc)
Minor currency pairs may exhibit higher volatility compared to major pairs due to the absence of the US dollar and the specific economic factors affecting the countries involved.
Exotic currency pairs consist of one major currency and one currency from a developing or emerging market economy. These pairs typically have lower liquidity, wider spreads, and higher transaction costs compared to major and minor pairs. Exotic currency pairs are less commonly traded and may exhibit significant price fluctuations due to economic and political uncertainties in the countries involved.
Examples of exotic currency pairs include:
- USD/TRY (US Dollar/Turkish lira)
- USD/ZAR (US Dollar/South African rand)
- USD/THB (US Dollar/Thai baht)
Exotic currency pairs are often associated with higher risk, but they may also offer higher potential returns for traders willing to accept increased volatility.
How to trade forex for beginners
There are two main types of analysis that traders use to predict market movements and enter live positions in forex markets – fundamental analysis and technical analysis.
A Forex trader will tend to use one or a combination of these to determine a trading style that best fits their personality.
Fundamental analysis
Fundamental analysis is concerned about the ‘why’ behind the movements in the Forex market. Forex and currencies are affected by a country’s economic strength, political and social factors, and market sentiment, amongst other factors.
News and Economic Data
Investors and banks look for strong economies to place their funds, in the expectation that their capital will appreciate. This is because the currency of that country will be in demand as the outlook for the economy encourages more investment. Any news and economic reports that back this up will in turn see traders want to buy that country’s currency.
Central Bank and Government Policy
Central banks determine monetary policy, which means they control things like money supply and interest rates. The tools and policy types used will affect the supply and demand of their currencies. A government’s use of fiscal policy through spending or taxes to grow or slow the economy may also affect exchange rates.
Technical analysis
Forex traders use technical analysis to study price action and trends on the price charts. These movements can help the trader identify clues about levels of supply and demand.
The aim of technical analysis is to interpret patterns seen in charts that may help you find the right time and price level to both enter and exit the market.
The three most popular charts in trading
Candlestick chart
The chart displays the high-to-low range with a vertical line and opening and closing prices. The difference to the bar charts is in the ‘body’ which covers the opening and closing prices, while the candle ‘wicks’ show the high and low.
If the candlestick is filled, then the currency pair closed lower than it opened. If the candlestick is hollow, then the closing price is higher than the opening price.
Bar chart
A bar chart shows the opening and closing prices, as well as the high and low for that period. The top of the bar shows the highest price paid, and the bottom indicates the lowest traded price.
The whole bar represents the currency pair's whole trading range and the horizontal marks on the sides indicate the opening (left) and the closing prices (right).
Line chart
While a bar chart is commonly used to identify the contraction and expansion of price ranges, a line chart is the simplest of all charts and mostly used by beginners. It simply shows a line drawn from one closing price to the next.
When connected, it is simple to identify a price movement of a currency pair through a specific time period and determine currency patterns.
How to start trading Forex
With Alpari, you can access the forex markets and execute your buy and sell orders through our trading platform.
You should always choose a licensed, regulated broker that has at least five years of proven experience. These brokers will offer you peace of mind as they will always prioritise the protection of your funds.
Once you open an active account, you can start trading Forex — and you will be required to make a deposit to cover the costs of your trades. This is called a margin account which uses financial derivatives like CFDs to buy and sell currencies.
It's important to remember that learning how to trade isn’t an overnight process. It takes time to become familiar with the markets and there’s a whole new vocabulary to learn.
This is why Alpari provides a wealth of resources in our Education section to help you learn how to trade Forex, as well as other important trading-related concepts.
A Practice account is a great way to experiment with different trading strategies, with virtual money do there's no risk attached! Once you’re ready to move on to live trading, we have a range of trading accounts and trading platforms to suit you.