What Is Forex Trading and How Does It Work?

Last Updated July 23rd 2021
14 Min Read

Foreign exchange trading or forex trading is something that the vast majority of people have done at least once in their lifetime.

Does that statement surprise you?

Maybe this is because of the fact that you are not familiar with the concept of forex at all, or maybe it is because you envision it to be some sort of an investment enigma like stocks, shares, and bonds you hear about in the movies.

However, have you ever travelled to another country? Have you exchanged some of your home countries currency for another?

This is pretty much what forex is and how you’ve probably already been involved in foreign exchange trading.

However, forex trading is more than this for many people. Forex trading is also referred to as a type of investment strategy, an opportunity for making a profit for many people around the world that are labelled or call themselves forex traders.

The basic idea behind forex trading is making money from fluctuating values of currencies.

It is an endeavour considered as an opportunity for earning money but like any other investment strategy, it is not without its risks.

There is a lot more to forex trading and if you are wondering what forex trading is and how does it work –  keep reading and you’ll find out!


What is forex trading?

what is forex trading

  • Forex trading is a method of investing.
  • Forex trading is speculating on the value of one currency against another. For example, making a prediction that the GBP (Great British Pound) will decrease in value against the USD (United States Dollar) with the aim of being correct and making money.
  • Forex trading decisions are often made based on fundamental or technical analysis. Fundamental being things like the news, for example, Brexit is a trading opportunity based on fundamental news, whereas technical analysis is looking at charts and recognising patterns, for example, previous levels of support or resistance in the price of a currency pair.
  • Forex trading is widely accessible, there are a huge number of individual traders that are normal everyday people, working a 9-5 job and using it as a potential extra source of income it is not just reserved for bankers or the rich.
  • Due to very volatile market conditions some people trade forex very short term and can be in and out of the market within minutes, as oppose to traditional investments such as purchasing stocks where you may hold on to them for a significant amount of years
  • Forex trading is a skill and one that could generate you a source of income but its not without its risks, you can make money but you can also lose money.

Just like any other skill, forex trading can be learnt and if you are interested in learning more (which is highly recommended before making any sort of financial decisions) you should consider taking a free forex trading course.

An in-depth free trading education course can help you start on the path to mindful and informed forex trading.

Lucky enough, we have created a free forex course for people exactly like yourself who are interested to learn more. You can find this course here.

Thanks to the simple nature of forex trading, there is a high rate of people entering the market as traders.

However, there is also a high rate of failure as many beginners enter the market without taking into account the number of factors they should understand before getting started.

It has been said that 90% of the trading beginners fail with their first trade but don’t let this dishearten you, just think about when you were first learning to ride a bike, did you succeed the first time you tried?

Most likely not, there’s a process and you have to give it time.

While a lot of people will quit on the first sign of a losing trade it’s those that perceiver and continue to learn that will ultimately prosper and the best way to become a good forex trader is learning how forex works.


So how big is the forex market?

how big is the forex market

In a nutshell, the forex market is the biggest and most dynamic financial market in the world with a daily volume of more than $5 trillion. It is considered to be the closest to the concept of “perfect market” because it is the most liquid one, it is open 24 hours a day, and it is available for everyone who wants to participate.

In addition, you are not required to have a large initial capital at your disposal in order to enter the market. In most cases, you won’t need to pay a high commission to your broker either.

Just like the largest financial institutions in the world, you can easily enter the forex market thanks to the internet. All you need to do is open a free trading account which you can do here and start putting what you have learnt into practice.  


What is a currency pair?

The first currency listed in the pair is called the base currency and the second one is called the quote currency.

The price of the pair is determined by the difference between both measured in one unit. Normally, the exchange rate will constantly fluctuate.


What's it like being a forex trader?

  • Being a forex trader does not mean that you have to be stuck to your computer screen 24/7.
  • A lot of forex traders trade in the market as a side job along with their conventional careers.
  • Due to certain trading tools such as an economic calendar, traders can plan when they will trade rather than being on the computer all of the time
  • Forex Traders have a lot of flexibility and freedom, as long as you have internet access you could trade from anywhere, even the beach.
  • It can be emotionally challenging to be a forex trader as they often deal with loses and cannot let it impact trading, in essence there can be no emotional attachment to money.
  • If you put in the time and effort to learn the skill it can offer financial rewards and most importantly freedom.

See also: How does an Average Person with No Experience Learn the Skills required for Trading Forex?

What are pips in forex trading?

Pips are the units that measure the increase or decrease in the price of a currency pair. Normally, the pip will be equal to a one-digit movement in the fourth decimal of a currency pair. To make things clearer for you, one pip is the increase in the pair GBP/USD when the price increases from $1.36471 to $1.36481. An exception is considered when the currency is listed in significantly smaller denominations. Like with the example with Japanese yen, a single pip is the equivalent of the movement in the second decimal place.


What is a spread in forex trading?

When taking a look at the forex quotes you will note the two different prices listed there that are available for each currency pair. These are ask and the bid prices. The ask price is basically the price at which you can buy the currency. The bid price, on another hand, is the price at which you can sell the currency. You will also note that the ask price is always higher than the bid price. This is the spread you will notice the price to buy your currency is a bit cheaper than how much it will be sold for. The difference between the ask and the bid price is known as the spread. The tighter the spread is, the more liquid the market is and this is the best case for all participants. However, this is not always the case and major price gaps may occur at times, especially during major news releases.

Every trade in the forex world is both a “buy” and a “sell”. In order to make a profit and depending on your trading strategy as a forex trader, you close the order whenever you decide that you can sell the currency you have purchased by purchasing another currency or simply exchange one currency for another. While this process of exchanging may seem like a bit confusing at first it is really not that hard once you become familiar with the basic mechanism of forex.

People also like: 6 Trading Mistakes that Will Cost You Money and How to Avoid Them

What does leverage mean?

As an example, if you are offered leverage of 1:100 by your forex broker, this pretty much means that you can trade with 100 times more money than the capital you have deposited into your trading account.

The high leverage in the forex world is the reason why so many people with a less funds available enter the market.

In fact, you are not required to have a lot of capital at your disposal in order to be able to trade forex. You can start with as little as $100 as an initial capital and this is something that other markets do not offer as an opportunity.

However, keep in mind that entering with $100 and expecting to become a millionaire overnight is completely impossible or at least very unlikely.

Your success as a trader and whether or not you will be able to make a profit from forex trading is a subject to many factors. Keep in mind that the leverage may be a subject of government regulations in your country and can be limited. However, there will be brokers regulated in other countries that can offer leverage as high as 1:1000 and even higher but not all brokers are good so it’s important to choose a reputable one such as one of our partners.


What are long and short trades in forex?

long and short trades in forex

The basic concept of the long and short trade consists of a couple of simple principles.

If you have placed a buy trade on EUR/USD in hope that the euro is going up against the USD this is also known as long position or going long on EUR/USD.

In a contrast, if you placed a sell trade on EUR/USD in hope that the Euro will decrease in value against the USD, this is called the short position or going short on EUR/USD.


What is analysis when referring to forex trading?

When it comes to forex trading, the analysis is not only the key but also the most important instrument of your forex trading strategy.

The two principal fundaments of the forex market analysis are fundamental analysis and technical analysis.

Fundamental analysis is news at its core, this news is often data released to show the economic condition of a country and includes various elements of a country’s economy including important events affecting the stability of the country’s currency, future prognosis, political events, and the possible impact on the market in terms of supply and demand.

This is a form of financial forecasting that has been used since the early days of forex trading. In order to be good at fundamental analysis, you would like to be familiar with the concepts of international economics.

Fundamental analysis is often used by market players aiming towards long-term trading and investing. However, it is not necessarily the best choice for forex beginners as it can be pretty overwhelming and even confusing to understand at first plus you will be bombarded with too much information you still don’t know how to prioritise.

However, once you master fundamental analysis and how to perform it correctly, you definitely increase your chance of predicting price movements and placing successful trades.

Technical analysis, on another hand, deals with only two main variables – time and price. Both are undeniable facts so the element of uncertainty is not present in this case. Both price and time are also strictly quantifiable elements.

In order to be able to make a good technical analysis, you would like to learn how to study charts. Some of the aspects of technical analysis also include drawing support and resistance lines, applying technical indicators, comparing candlestick formations, identifying key levels, etc. Technical analysis is the only thing available to quick-style traders but it is also often used by traders aiming towards long-term trading too.

Do you want to learn more about technical analysis? Make sure to check out this article here or even better, take part in our online course here.


In conclusion

Forex trading is a way of investing in the currency market by predicting the direction of the value of one currency against the other.

There are lots of different factors you can learn about that may increase your ability to predict the direction of currency pairs and therefore become a successful forex trader.

There is a good chance or even a guarantee that you will lose some trades but good things take time, one loss or a few speed bumps along the way is not a reason for you to give up.

At the end of the day, fortune favours the prepared and this one is absolutely working rule in the context of forex trading.

It is pretty understandable to see why so many forex trading newbies feel almost lost at this initial stage when they are bombarded with tons of information, recommendations, and hot tips.

If you come with little to no training and with the attitude of flipping a coin a magically turning those $10 you have started your account with into $1,000, well… you will be disappointed as the failure is just a few clicks with the mouse away.

However, your willingness to learn, develop, improve, and dig deeper is the best way to start when carving out your way to successful trading.

There is nothing that could prepare you better and help you master forex trading than a high-quality, comprehensive, and up-to-date forex trading course.

Make sure to check out the one offered here at Trading Education in the link provided above in the article. Furthermore, you can continue learning about forex trading and how does it work by browsing our articles archive here.

Do you find this article helpful? Then make sure to like it, leave a comment, and share it with others!