If you’re new to Forex trading, chances are that there are still many trading concepts and basic terminology that you’re not fully familiar with. In this guide, we’ll cover everything you need to know to make your trading journey as seamless as possible, mention the best time to trade Forex, and showcase a few of the most important differences between Forex and stock trading. By the end of the guide, you’ll have a solid foundation of the most important trading concepts so you can get your feet wet on the most exciting financial market in the world.
What is the Forex market?
Forex, or FX, is an abbreviation of the term "Foreign Exchange", and represents the world's largest financial market. According to the Bank of International Settlements, the Forex market trades more than 5 trillion US dollars daily and dwarfs all other financial markets in size. For comparison, the daily turnover of the New York Stock Exchange is around $28 billion – around 190 times less than on the Forex market.
The Forex market is the marketplace of the world’s currencies. Since this is an over-the-counter market, there is no centralised exchange on which to trade currencies, such as with stocks. Instead, currencies are traded during Forex trading sessions, of which the most important are the New York session, the London session, the Tokyo session, and the Sydney session. Since these sessions are located all around the world spanning all time zones, Forex traders can trade on the market around the clock, Monday through Friday.
The large number of market participants is one of the main reasons why the Forex market has such a large daily trading volume. From large investment and commercial banks, governments and central banks, to companies, individual traders, and investors – they all participate on the Forex market and all have their own objectives. Investment and commercial banks exchange various currencies on a daily basis and some of them even speculate on exchange rate movements, while governments and central banks buy and sell currencies to manage their monetary policies, companies sell their products abroad in foreign currencies and need to repatriate their overseas earnings, and individual traders and investors try to profit from movements in exchange rates.
While it was extremely difficult to enter the Forex market a few decades ago, entry barriers have been lowered with the advance of information technology and the Internet. In addition, up until 1973 and the end of the Bretton Woods Agreement, most major currencies were pegged to the US dollar which in turn was pegged to the price of gold. This meant that currencies didn’t fluctuate against each other and the Forex market didn’t exist as we know it today. With the end of the Bretton Woods Agreement, countries started to adopt a free-floating currency regime, and exchange rates are now determined by the supply and demand forces of the market. Today, all you need to start trading on the world’s largest financial market is a computer with Internet access, a brokerage account, and a trading platform installed on your computer.
What is Forex trading?
Forex trading represents the act of buying and selling currencies to make a capital gain. Similar to stock traders who try to buy a stock cheap and sell it later at a higher price, Forex traders want to buy a currency cheap and sell it later for a profit. However, traders can also profit from a fall in price by short-selling the currency.
All currencies are quoted in pairs, with the exchange rate representing the price of the first currency expressed in terms of the second currency. In Forex jargon, the first currency is called the base currency, and the second currency is called the counter currency. If the EUR/USD (euro vs US dollar) pair trades at 1.30, this means that 1 euro costs 1.30 US dollars, or it takes 1.30 US dollars to buy 1 euro. If a trader thinks that the exchange rate will rise in the future, i.e., the euro will become more expensive in dollar terms, they would buy the EUR/USD pair and sell it later for a profit if their analysis proves correct.
Forex traders can also profit from overnight swaps, which are credited to your account on a daily basis if you buy a currency that carries higher interest rates and sell a currency that carries lower interest rates. At this point, it’s worth mentioning that any time you buy a currency pair, you’re basically buying the base currency and selling the counter currency. For example, buying the EUR/USD pair would mean that you buy the euro and sell the US dollar simultaneously. On the other hand, if you sell the EUR/USD pair, you’re basically selling the euro and buying the US dollar simultaneously.
Basic Forex terminology
Now that you know what Forex is and how Forex trading works, it’s time to take a look at some basic Forex terminology. Whether you read somewhere about “pips” or “spreads”, this is the basic terminology that all Forex traders should know.
Pips – A pip is the smallest increment that a currency pair can change in value. It represents the fourth decimal place of an exchange rate. In certain cases, such as in pairs which involve the Japanese yen as either the base or counter currency, a pip can be located at the second decimal place. A pipette is one-tenth of a pip, i.e., ten pipettes make up one pip.
Spread – A spread represents the transaction cost for opening a position. The spread is simply the difference between the buying and selling price of a currency pair (Bid and Ask prices), and this is usually the only fee you’ll pay when trading Forex.
Position Size – The position size is the size of your trade and represents the amount of the base currency that you’re buying or selling. The standard position size in Forex trading is called a standard lot, which amounts to 100,000 units of the base currency. For example, if you buy one standard lot on the EUR/USD pair, you’re basically buying €100,000 and selling the same amount of US dollars. Of course, you can determine how large your position size will be, with most brokers offering mini lots (10,000 units of base currency) and micro lots (1,000 units of the base currency) nowadays.
TP and SL – Take Profit and Stop Loss orders are an extremely important concept in Forex trading. A Take Profit order is used to lock in your profits once the price reaches a pre-specified level by automatically closing your open position. A Stop Loss order, on the other hand, is used to prevent large losses by automatically closing your position once the price goes against you by a pre-specified amount. Always use Stop Loss orders on all of your positions, or you will eventually blow your account with a single losing position.
Leverage – Leverage is a concept which is extremely popular in Forex, and one of the main reasons why so many traders are attracted to the world of Forex trading. Leverage is a loan from your broker which allows you to open a much larger position than your initial trading account balance would allow. Leverage is expressed in ratios, such as 50:1, 100:1, and 200:1, to name a few. A 100:1 leverage ratio allows you to open a position which is 100 times larger than your trading account.
Margin – When trading on leverage, your broker will allocate a small portion of your trading account as the margin for the leveraged position. A margin basically acts as collateral for the loan that your broker is providing to you. A 50:1 leverage requires a 2% margin, while a 100:1 leverage requires a 1% margin of the total position size that you’re trading.
Timeframe – Timeframes are closely related to price charts of currency pairs, and represent the amount of time that is incorporated in a single bar or candlestick on the chart. Popular timeframes include the 1-hour, 4-hour, and daily timeframes, meaning that a single bar or candlestick includes the last one hour, 4 hours, or 24 hours of trading, respectively.
What currencies are traded on Forex?
Now that you know what Forex is and the basic Forex terminology, let’s dig deeper into what is traded on Forex – currencies.
Currencies can be grouped in a variety of ways, but we’ll use the most popular classification of major currencies and exotics. Major currencies are the most traded currencies in the world, and include the US dollar, British pound, euro, Swiss franc, Canadian dollar, Japanese yen, Australian dollar, and New Zealand dollar. These eight currencies are the major currencies in the Forex market.
Exotic currencies are less traded currencies with lower liquidity than major currencies, and include names such as the Turkish lira, Czech krona, Argentine peso, and Mexican peso, to name a few. These currencies are usually much more volatile than the major currencies, and should therefore be traded by more advanced traders and professionals who have a good understanding of risk management.
Forex traders cannot trade on single currencies, only on currency pairs. Pairs that include the US dollar as either the base or counter currency are called major pairs. In fact, the US dollar is involved in around 80% of all Forex transactions, which emphasises how important the greenback (nickname for the US dollar) is in Forex. Examples of major pairs are EUR/USD, GBP/USD, and USD/JPY.
Currency pairs that don’t include the US dollar, but include the remaining seven major currencies, are called cross currency pairs. Examples of cross currency pairs are the GBP/JPY, AUD/NZD and EUR/GBP.
When is the best time to trade Forex?
Since we’re covering the topic of Forex trading, let’s take a look at the best times to trade on the market. As you already know, the Forex market is an over-the-counter market with no centralised exchange, and currencies are traded during Forex trading sessions which span across all important time zones. The most important Forex trading sessions are the New York session, the London session, the Tokyo session, and the Sydney session.
Of these sessions, the London session is by far the largest trading session with the highest trading volume, closely followed by the New York session. This means that traders will usually find the largest price movements during these trading sessions, especially when the London and New York session overlap from 1:00 PM to 4:00 PM (GMT+1). The following table shows the open market hours of the four mentioned trading sessions
Sydney Open – 7:00 AM
Sydney Close – 4:00 PM
Tokyo Open – 9:00 AM
Tokyo Close – 6:00 PM
London Open – 8:00 AM
London Close – 4:00 PM
New York Open – 8:00 AM
New York Close – 5:00 PM
The New York-London overlap is the most active time of the day, during which currency pairs exhibit the largest price swings. Day traders and scalpers will find this part of the day the most productive and cost-efficient to place trades.
Main differences between Forex and stocks
Continuing our guide on Forex trading, we will be covering the main differences between Forex and stocks in the following lines. There are some important advantages and drawbacks of both markets, and here are the most obvious ones:
1) Open Market Hours – One of the main differences are the open market hours of both markets. While the Forex market is open around the clock, Monday through Friday, the stock market is limited by the open market hours of the stock exchange. This means that you can place trades on the Forex market whenever you find a trade-worthy opportunity.
2) Tradeable Instruments – The second important difference is the number of tradeable instruments on both markets. Whereas the stock market has thousands of stocks to trade on, the Forex market has only a limited number of currencies. This isn’t necessarily a drawback of the Forex market, as traders can focus on a few currencies and never miss a trading opportunity, while stock traders have to follow dozens or hundreds of stocks which may be very time consuming.
3) Trading Costs – The last difference between Forex and stocks that we’re going to mention concerns trading costs. The Forex market has one of the lowest transaction costs of any financial market, with the spread usually being the only fee that you have to pay when placing a position. On major pairs, such as the EUR/USD pair, the spread can be as low as 1 pip. The stock market has relatively higher fees, and some brokers also impose certain commissions on stock trades.
What is Forex training?
To start trading Forex, one should first learn how to properly analyse the market. Otherwise, there is a large chance that the trader will wipe out their account by accumulating a large number of losing positions. To prevent this from happening, beginners on the market should first train on how to trade and gain experience along the way, and the best way to do so is by opening a demo trading account.
A demo account is a risk-free way to get acquainted with the market without risking real money. It can be used to develop your trading plan and strategy, test various trading strategies or simply play with your trading platform’s charting tools. In addition, beginners should also pick up a good book about Forex or join an online trading course which covers the main trading concepts in a concise and user-friendly way.
Build a trading plan
We cannot conclude our Forex guide without mentioning the importance of a trading plan. As its name suggests, a trading plan is a comprehensive action plan that includes everything important for trading, such as a detailed description of your trading strategy, risk and money management, way of analysing the market, etc. If you’re serious about Forex trading, you need to build a trading plan and have it in writing for you to refer to whenever you get stuck.
Conclusion – What does it mean to trade Forex?
Forex trading is not as difficult as it seems. In this guide, we covered what Forex is and explained the most important concepts that every beginner should know. Forex is the largest financial market in the world where trillions of dollars’ worth of currencies change hands on a daily basis. Before you open a real trading account, make sure to familiarise yourself with the market by practicing on a demo account first and learning the basic market terminology. Try to focus on the most volatile part of the day for now, which is the New York-London session overlap, and always use Stop Loss orders to prevent excessive losses and blowing your account. Finally, build a written trading plan, which includes your trading strategy, risk, and trade management guidelines, which you can always refer to when you have difficulties analysing the market.