Forex - What Is Forex Trading?

Forex (Foreign Exchange Market) is the international currency trading system. Trading involves the making of money by speculating on whether currencies are going to go up or down in value.

Have you ever got back from holiday and hung on to your unspent Euros because the news has told you that pound is strong at the moment. When you cash them in a month later the rates have changed and get more pound for your Euros.

That was a very basic example of the principle of Forex trading. The difference with Forex is you don’t actually buy currency, but bet on whether or not it will go up or down.

You use online ‘providers’ to ‘place your bets’ for you, and pay you your winnings. They don’t make a commission charge, but they do make a small profit on the exchange rates they charge (the ‘spread’). (Forex platforms are not the only way to trade currencies, but they are relativley safe for the beginner, and potentially profitable. For further details on alternative methods of currency trading see Which Currency Trading Platform?

Example Of Opening A Forex Trade

Before we get too bogged down with intricacies of the system, lets have a look at an example of a bet, or what is known as a ‘trade’. Please note that most ‘providers’ deal in dollar accounts, so we’re using a dollars example to get you used to the idea.

Try to ‘suspend your disbelief’. At certain points you will be thinking “How the hell does that work?”. Don’t try to figure everything out all at once, it will become clearer. Besides, you don’t need to know how the whole system works to make money, you just need to know how to trade well. So here goes;

You turn your computer on first thing in the morning and log into to your ‘provider’ software.
After looking at your Broker’s charts, you assess that there is a fairly good chance that the Dollar will continue to weaken against the Euro.
So, as the Euro is going up, you open a trade by ‘Buying’ the Euro at 1.3875 with a $200 stake.
You close the deal later in the day, and the rate has gone up to 1.3972
This is a rise of 97 pips*, and equates to a profit of $95.50
With most software, your profit/loss is tracked in real-time, and is displayed in Dollars
so you always know where you are financially.
Not bad for a few minutes ‘work’, and is a real example, based on a practice account with an online broker.
In a mini account, a one pip movement equates to one Dollar
The profit of $95.50 is due to the $1.50 spread* on the account
(97 – 1.50 = 95.50)
* For an explanation of ‘pips’/’spread’ see our Trading Glossary

Trading Terminology

The example above is called a ‘long’ trade, which means you are betting on something going up in value (the Euro).
The trade was made on the currency pair EUR/USD.
The first part – the Euro – was ‘borrowed’ or ‘BID’ with the second part of the pair – the Dollar.
(For ‘short selling’ see our Trading Glossary)

Currency Pairs

The first part of a pair is called the base
The second part is called the counter currency or terms
You buy or sell the base with the counter currency
In the example above, we bought euros (the base) expecting them to go up
We bought them with dollars (counter currency)
When the deal closed, we ‘sold the Euro’ and bought back more dollars.
Don’t get too hung up on this!
Spend your time figuring out how to make good trades,
not how the market works.

That was in essence how a trade is placed, however there are options applied to every trade that should be, and in the case of leverage, must be used.

Leverage A.K.A. Risk Level

Providers will ‘lend’ you money, with a safety net.
They will ‘lend’ you up to 400 times your original ‘stake’,
(and, you don’t have to pay it back)
If you asked for a leverage of 1.100, for every dollar you place on the trade, they lend you 99 more.
So from the above trade example your $200 stake is now worth $10,000 (200 x 50).
You have to use leverage, because of the minimum lot sizes involved in currency trading
(as currency trading works on a global scale, lot sizes are large by nature)
Leverage doesn’t increase profit in real terms, however it allows you to trade with less money,
but if the trade goes the ‘wrong way’ it will close your deal faster than without leverage
In the above example, you could have opened the trade with $50 and 200 risk level.
You would have won the same amount of money, a massive mark-up percentage wise (c 200%)
But, if the Euro had moved 50 points down against the dollar (remember 1 pip or point =$1), your Trade Stake would have been wiped out.
(Dependent on your broker’s default margin call level, the trade could be wiped (margin call) a lot sooner).
However, with a $200, or even $100 stake you would still be in the game, and if the Euro swung back around and moved up,
you would be able to profit.
Also note: some brokers work on a fixed leverage basis, which means that you have no choice other than to trade at e.g. 100:1.
(for more detail on leverage usage and its implications, see Forex Tips and Techniques.

Forex Safety Net

If the trade ‘goes sour’, there is an automatic ‘trade cut-off’.
It is activated if your trade goes too far the wrong way.
It will kick in, and close the trade when your stake has been wiped out.
You can adjust this yourself – see stop loss below

Stop Loss (A.K.A. Stop/Limit Order)

You can alter the ‘stop loss’ level yourself to kick in before all your stake investment disappears.
It’s better than the safety net, because you can save some of your original stake.
You do this to get out while you’re ahead, before your profits drop back
If you are a beginner, you should always use this function, or have an exceptionally good reason not too.
There will be an obvious Stop Loss control on your trade options displayed in simple Dollars e.g. Stop Loss at $100
You can alter you Stop Loss while the trade is still open
For more details and advice on the implications of setting stop loss levels see our Forex Tips and Techniques.

Take Profit (A.K.A. Profit Target)

This is the opposite to stop loss, and is again usually displayed in Dollars
You do this to get out while you’re ahead, before your profits drop back.
It will kick in and close the trade at a point that you decide.
Always set this too, (Unless you really know what you are doing!).
You can alter you Stop Loss while the trade is still open
For more details and advice on the implications of setting Take Profit levels see our Forex Tips and Techniques.

How to know what trades to place? Trends are a good place to start

Trends

Many traders base their trades on following trends
A trend is e.g. the dollar has been rising over the past week.
You can see the trends in chart form which makes them easy to spot.
Trend tracking is included in most providers software.
Trends can be viewed over hours, days, weeks, months, and years.
Its not guaranteed, but its very popular.
Going against the trend is risky and requires experience

Forex Advantages

You can open accounts from as little as $25
You can open a trade from as little as
All brokers listed on this site have demo accounts available for beginners
Broker platforms are set up with functions to automatically stop your account being wiped out.
(brokers don’t want you wiped out, its in their interests that you become a successful trader, not a loser)
The maximum amount you can lose on a trade is limited to the initial investment of the trade. (With the rare exception of extreme market conditions, in which brokers tend to absorb the loss themselves)

Forex Disadvantages

With many brokers you can only trade currency pairs, however this is changing.
You can’t set stop loss/take profit to precise figures e.g. $53, only multiples of $50 or $100

Forex is rapidly becoming the most popular form of Trading as it is now accessible not only to high rollers, but through the introduction of mini accounts you can start trading with only $25. Another reason that Forex trading has become so popular is that many brokers have developed software specifically with the beginner in mind, and therefore it is very user friendly.