What is Forex Trading?

What is forex trading? What is a currency pair? What is a currency trading point (PIP)? What are the types of forex trading? How to trade forex? How to make money with forex? What are the US forex trading platforms? What are the forex trading hours and forex trading strategies? Is forex trading risky? Is it more risky than stock trading? After reading this article, you will understand the above questions in detail.

Foreign exchange trading , in English, is Forex Trading . Foreign exchange trading refers to a trading method in which investors make profits by buying and selling the exchange rate differences between different currencies .

The currencies of different countries (or regions) have different denominations. For transactions between different countries or regions, different currencies need to be exchanged, which is the most basic foreign exchange process. The principle of foreign exchange trading is to predict the exchange rate trend between different currencies, buy or sell currencies, and obtain the profit of exchange rate difference.

Foreign exchange trading is one of the largest and most active financial markets in the world, involving major currencies such as the US dollar , euro , yen , and pound , as well as some smaller currency pairs. The main participants in foreign exchange trading include banks, large multinational companies, investment institutions, and individual investors.

Foreign exchange trading is risky and requires investors to have certain market analysis and risk control capabilities. At the same time, since the foreign exchange market is open 24 hours a day, investors are also required to have strong time management and psychological qualities.

With the maturity and expansion of the financial sector and the growth of online electronic transactions, foreign exchange has begun to have a different trading purpose from the original one and become an investment product. However, since foreign exchange trading is an investment that uses leverage, investment should be cautious.

What is Forex Trading?

Forex Trading is often confused with Foreign Exchange . Here are the differences between the two :

A. Foreign exchange

Foreign Exchange is the basic function of foreign exchange. It is the process of exchanging one currency for another for various reasons. It generally involves the exchange of physical currency.

For example, if you are coming to the United States from China for the first time, you may need to exchange some RMB for US dollars in advance to facilitate your trip in the United States.

It is usually used in business, trade or tourism, or by banks or individuals to make a profit by buying a currency that has appreciated in value relative to the currency being sold.

B. Forex Trading

Forex Trading is the name used in the financial field. During the transaction, the purpose is generally not to exchange physical currency, but to gain profits by predicting the exchange rate. The place where foreign exchange transactions are conducted is called the foreign exchange market.

Forex Trading is different from the stock market which has a physical trading venue. The foreign exchange market is a global electronic trading platform, a global network market composed of major banks and other financial institutions in various countries. It is currently one of the most active markets in the world, with an average daily trading volume of up to 5 trillion US dollars, far higher than the total value of the US stock market.

When conducting foreign exchange transactions, investors trade in the form of currency pairs, that is, selling one currency and buying another currency at the same time.

Each currency in a currency pair is listed as a three-letter code consisting of two letters representing the country or region where the currency is located and one letter representing the currency itself. For example, USD stands for United States Dollars , GBP stands for British Pounds, and JPY stands for Japanese Yen.

What is a currency pair?

Currency pair , in English it is called Currency Pair .

For example, a currency pair appears in the form of “GBP/USD”.

• The first currency (before the “/”), which is the British pound in this case, is called the base currency and is the currency the trader wants to buy;
• The second currency (after the “/”), which is the US dollar, is the quote currency, that is, the currency to be sold.

For example, the unit trading price of GBP/USD is 1.35361, which means that if you want to buy/get 1 pound, you need to sell/pay 1.35361 US dollars.

The base currency value is usually 1, which helps traders intuitively understand the amount of local currency they need to pay.

At present, there are four main types of currency pairs in the foreign exchange market according to different transaction volumes:

1. Major currency pairs

Major currency pairs are currency pairs with the United States as the main currency.

The main currency pairs at present are: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CAD, USD/CHF and NZD/USD, which account for 75% of global foreign exchange transactions.

2. Minor currency pairs

Minor currency pairs are traded less frequently and these pairs usually feature a major currency other than the U.S. dollar. They include: EUR/GBP, EUR/CHF, GBP/JPY.

3. Exotic currency pairs

Exotic currency pairs are currency pairs where the major currency pair comes from a small or emerging economy. Examples include: USD/PLN, GBP/MXN, EUR/CZK, etc.

4. Regional currency pairs

Regional currency pairs are currency pairs within a specific geographic region, such as the EUR/NOK pair within the Scandinavian region, or the AUD/NZD pair within the Australasia region.

What is a pip (PIP) in Forex trading?

PIP stands for Percentage In Point, or Price Interest Point, which is abbreviated as “point” in Chinese. It represents the smallest unit of fluctuation in a currency pair, that is, the basic unit of exchange rate change. PIP can be used to measure the trend of currency pairs.

In most currency pairs, currency pips are sometimes specified as the fourth decimal place of the currency pair, for example, if the EUR/USD moves from $1.35361 to $1.35371, it means it has moved one “pip”.

If the quoted currency is a very small denomination currency, such as the Japanese Yen JPY, the second decimal place can be used. For example, if EUR/JPY appreciates from ¥172.119 to ¥172.129, it moves one point.

In Forex trading, the “spread” is the difference between the bid and ask prices of a Forex pair. For example, if the bid price of EUR/USD is 1.7645 and the ask price is 1.7649, the spread is 4 pips, and the spread will vary from dealer to dealer.

What are the types of foreign exchange transactions?

There are three main types of foreign exchange trading:

• Spot FX
• Forward foreign exchange
• Futures Forex

1. Spot foreign exchange

Spot foreign exchange is called Spot Exchange Transactions in English, also known as spot foreign exchange. It is a physical exchange between currency pairs. One of the two parties to the transaction delivers an agreed amount of currency to the other party and receives a specified amount of another currency at the spot exchange rate for settlement.

The spot foreign exchange market is where currencies are bought and sold based on their trading prices.

Spot foreign exchange accounts for the largest proportion of foreign exchange transactions because it provides the “underlying” physical assets for the other two types of foreign exchange transactions.

The price of a currency pair in the spot market is determined by supply and demand, and its influencing factors include current interest rates, economic performance, current political situation, etc. of the countries involved in the currency pair.

2. Forward foreign exchange

The English name of forward foreign exchange is Forward Exchange Transaction.

Forward foreign exchange is a foreign exchange transaction in which both parties agree to specify the currency, amount, exchange rate, delivery time and other transaction conditions, and actually deliver the goods upon maturity.

This type of transaction often occurs in international trade. In order to reduce foreign exchange risks, exporters with forward foreign exchange income sign a contract to sell forward foreign exchange with a bank. When the forward foreign exchange expires, the exporter sells the foreign exchange income to the bank at the contract exchange rate to prevent losses due to exchange rate depreciation.

Similarly, importers with forward foreign exchange expenditures can also sign forward foreign exchange contracts with banks and purchase foreign exchange from banks at the contract price when the contract expires, thereby preventing increased costs due to rising exchange rates.

The forward exchange rate quoted by the bank is usually the difference between the forward exchange rate and the spot exchange rate. The difference may be negative or positive after the forward maturity. Therefore, the forward exchange rate may be higher or lower than the spot exchange rate.

3. Foreign exchange futures

The English name of foreign exchange futures is Forex Futures.

A foreign exchange futures contract is a standardized contract between two parties on an exchange, such as the Chicago Board of Trade ( CBOT ). It is a futures contract with exchange rates as the underlying asset and is used to avoid exchange rate risks.

In the United States, the National Futures Association ( NFA ) is responsible for regulating the futures market. Foreign exchange futures contracts contain specific transaction details, including the target transaction rate, the number of trading units, the delivery and settlement dates, and the minimum price increment that cannot be customized. The exchange acts as the counterparty to the trader and provides clearing and settlement.

Upon maturity, both parties can settle in cash at the relevant exchange, and futures foreign exchange contracts can also be bought and sold before maturity.

Futures Forex are regulated by exchanges, so typically large international companies use Forex futures contracts to hedge against future exchange rate fluctuations, but speculators may also participate in these markets to make a profit.

How to trade Forex? How to make money with Forex?

Before the advent of internet trading, it was difficult for individual investors to trade forex. Most forex traders were large multinational corporations, high net worth individuals or hedge funds, as forex trading requires a lot of capital.

With the development of Internet technology, many online trading platforms have been established. With the help of these platforms, some secondary markets have emerged that allow individual traders to trade foreign exchange. The establishment of secondary markets through banks or brokers allows retail investors to easily enter the foreign exchange market.

Most online brokers or traders provide individual investors with very high leverage trading, allowing investors to control large transactions with small amounts of money and obtain high profits, but at the same time they also bear great risks.

Before individual investors prepare to enter the foreign exchange market and during the transaction, they need to pay attention to the following points:

1. Understand foreign exchange knowledge

Although the principle of foreign exchange trading is not complicated, there are still many tricks and key information selection in the investment process, which requires professional knowledge. For example, the leverage ratio of foreign exchange trading is higher than that of stocks, the factors affecting exchange rate changes are different from those in the stock market, and how to calculate the profit of foreign exchange trading.

2. Open a personal account

Investors need to open a forex trading account with a brokerage firm.

Typically, online brokers do not charge commissions, but instead earn their profits through the forex spread.

Different online brokers have different requirements for investors’ initial investment amounts. For novice investors, it is a better choice to choose a broker with a lower initial amount requirement.

3. Develop a trading strategy

After understanding foreign exchange knowledge and learning market analysis, developing an effective strategy that suits your investment style is the best way to avoid risks and earn returns during the transaction. This strategy can be obtained through self-analysis or through recommendations and discussions with brokers. No matter which one, investors should consider reducing risks first. 

4. Master account information

Once you start trading, be sure to check your account at the end of each day, because the foreign exchange market is different from stocks, etc., which have regulated trading hours on specific exchanges. Foreign exchange trading is conducted continuously for 24 hours.

This means that when investors end their trading for the day and do not close or close their positions in time, they may incur losses while away. Of course, it is also possible to gain returns, but for safety reasons, it is a necessary good habit to check the account status when closing a transaction.

5. Maintain a positive attitude

The foreign exchange trading process is often full of ups and downs like a roller coaster. When the worst happens, whether you can face it calmly and decisively choose to add or stop loss is a compulsory course for beginners and a necessary quality for advanced investors.

Many beginners are prone to large losses, but when they calm down and analyze the situation, they often come to the conclusion that “it shouldn’t have been like this just now”. However, there is no regret medicine in foreign exchange, just like any other investment. You have to accept the loss if you gamble. Therefore, maintaining a good mentality is a skill that should be possessed at all stages of investment.

After understanding the process and necessary conditions of foreign exchange trading, how does foreign exchange trading benefit you? The principle is indeed very simple, which is the difference between the rise and fall of the currency pair and the selling and buying spreads provided by the broker.

The dealer or bank will provide the current sell price and buy price of the target currency pair.

6. Buy

Buying can also be called going long.

For example: The current price of EUR/USD is 1.07170/1.07190. If an investor believes that the euro will rise, he decides to buy the euro now and buys it at the price of 1.07191.

If the euro rises, when its price rises to 1.07370/1.07390, the investment will rise by 20 points. If you decide to close the position now, you will sell it at 1.07370 and earn a return of 18 points. The dealer or bank will charge a commission of 2 points from the transaction.

7. Sell

Selling is also called shorting.

If the investor believes that the euro will fall, he decides to open a euro sell position, that is, sell the holding amount. Because it is a sell, the price is 1.07170, and then the euro rises to 1.07370/1.07390. At this time, the transaction loses 20 points. If you choose to close the position, you need to buy at 1.07390, which means that the investor actually loses 22 points, of which the 2-point difference is the commission charged by the dealer or bank for setting the buy-sell spread.

It can be seen that due to the spread between the selling price and the buying price in foreign exchange transactions, the gains and losses are not in a 1:1 ratio. This part of the spread will vary according to different brokers and will directly affect the investors’ returns.

During the transaction process, investors do not need to pay all investments in full, but instead pay a certain percentage of margin to trade. When closing a position, they will earn a corresponding proportion of returns or lose a corresponding proportion of funds, which has a leverage effect.

What are the US foreign exchange trading platforms?

Online brokers that allow forex trading in the United States include TD Ameritrade, Ally Invest, and Interactive Broker, as well as several other well-known brokers or banks.

IG

IG, the full name of which is IG Group, was founded by Stuart Wheeler in 1974. It is the world’s first foreign exchange spread trading company and is part of IG Group Holdings Plc, a publicly traded conglomerate with the London Stock Exchange code: IGG.

IG Group officially entered the US market in early 2019. With a spread of 0.59, it supports users to invest in a variety of currency pairs. IG adopts the company philosophy of “either go big or go home”. With low spread costs, emphasis on customer service and education, actionable research and functional user interface, it has become highly competitive in the online foreign exchange broker market in a short period of time. IG Group was named the best foreign exchange broker for US traders in 2020 by Investopedia.

Saxo Bank

Founded in 1992, Saxo Bank operates several regulated banks and is licensed in six Tier 1 jurisdictions, making it one of the safest brokers for trading Forex and CFDs.

Saxo Bank is the exclusive broker and requires a minimum deposit of $10,000 to open an entry-level account. Saxo Bank’s Platinum and VIP accounts require $200,000 and $1,000,000 respectively.

Saxo Bank offers commission-free trading of 182 forex pairs at a spread of 0.4 pips. When the investor’s monthly trading volume is less than $50,000, a monthly account fee of $3 is required.

Saxo Bank is committed to the FX Global Code *, an evolving interbank standard centered around enhanced disclosure and best execution to promote integrity and transparency in the global FX market.

Launched in August 2018. It is a set of global principles for good practice in the foreign exchange market, which aims to provide a common set of guidelines to promote the integrity and efficient operation of the wholesale foreign exchange market. It was developed in collaboration with central banks and market participants from 16 jurisdictions around the world. The purpose of the Global Code is to promote a strong, fair, liquid, open and appropriately transparent market in which diverse market participants, supported by a resilient infrastructure, can trade confidently and efficiently at competitive prices that reflect available market information in a manner consistent with acceptable standards of conduct. The Global Code does not impose legal or regulatory obligations on market participants, nor does it replace regulation, but is intended to complement any and all local laws, rules and regulations by identifying global good practices and processes.

CMC Markets

Founded in 1989, CMC Markets is publicly traded and regulated in four Tier 1 jurisdictions and two Tier 2 jurisdictions and is also one of the safest brokers for trading Forex and CFDs.

CMC Markets is a leader in low-cost trading, offering Forex trading costs significantly below the industry average.

The Next Generation platform launched by the company offers a large selection of nearly 10,000 tradable instruments. It also provides an excellent user experience with advanced tools, comprehensive market research and excellent mobile applications, and you can open an account for free in just three steps.

CMC Markets offers these active traders a liquidity rebate of $5 per million USD when their monthly trading volume exceeds $25 million USD, and up to $10 per million USD for investors with monthly trading volume exceeding $300 million USD. Using an average spread of 0.74 pips for regular users, the total cost for the highest tier users is 0.64 pips.

Forex Trading Hours

The biggest difference between foreign exchange and other financial investment products is the trading time. Unlike trading in a certain center with fixed trading hours, the trading hours of foreign exchange are mainly distributed in four major foreign exchange trading centers in different time zones: London, New York, Sydney and Tokyo.

Since there is no centralized trading venue, foreign exchange transactions are carried out continuously 24 hours a day in different regions around the world.

In the United States, investors mainly trade from 5 pm EST on Sunday to 4 pm EST on Friday.

However, since the foreign exchange market operates around the clock, investors cannot trade around the clock.

This means that there may also be differences in forex prices between Friday’s close and Sunday’s open. Investors need to be aware of weekend forex trading hours and change their positions accordingly.

In addition, the opening hours of the global foreign exchange market will be different in March, April, October and November because different countries change to daylight saving time on different days.

What are the foreign exchange trading strategies?

Formulating a trading strategy is a very important part of the foreign exchange trading process, which will directly lead to the conduct or suspension of transactions, and thus affect the investors’ gains or losses.

For novice traders, you can first understand several basic foreign exchange trading strategies.

1. Follow the trend

Use Forex trading technical analysis tools to identify market trends, that is, the direction of market movement, or more accurately, the volatility of the Forex market, because the Forex market does not move in a straight line, but fluctuates continuously with obvious peaks and troughs.

By analyzing the peaks and troughs, we can understand the trends of the foreign exchange market, which mainly include upward trends, downward trends and stable trends.

In response to these three trends, most ordinary investors will adopt buying, selling and waiting operations.

2. Breakout Trading

Breakout trading is one of the simplest strategies in forex trading and a good choice for beginners.

A “breakout” is a price movement outside of a support or resistance area. Support is when prices fall to a certain point and begin to rebound due to market injections, and resistance is when prices rise to a certain point and stop rising and begin to fall.

When prices rise above a resistance area, a breakout may occur, known as a “bullish” breakout pattern. When prices fall below a support area, it is known as a “bearish” breakout pattern.

Regardless of the pattern, a breakout means that a new round of market volatility may have begun, and investors who join the trade can use volatility to their advantage by joining the new trend.

3. Range Trading

Range trading is the opposite of breakout trading, which is trading within a relatively stable range. Its profit is based on the fact that prices usually remain stable and predictable within a certain period of time, and investors use price judgment to make short-term multiple transactions to obtain returns.

4. Fundamental analysis

In fundamental analysis, traders look at a country’s economic fundamentals to determine whether the local currency is undervalued or overvalued and predict the future trend of that currency against another currency.

Fundamental analysis can sometimes be complex, involving numerous factors of a country’s economic data that can indicate future trade and investment trends. Experienced investors simplify it by focusing on a few major indicators, including GDP, industrial production, inflation data, and housing data.

5. Arbitrage Trading

A carry trade is an investment strategy whereby investors take advantage of interest rate differences between countries to profit. Investors who employ a carry trade “borrow” a low-interest currency to buy a higher-interest currency.

Carry trading is one of the most popular trading strategies in the foreign exchange market, but it still has certain risks. For example, this type of trading usually has a high leverage ratio, which leads to overcrowding and limited liquidity.

Is forex trading risky? Is it riskier than stock trading?

Foreign exchange transactions, like any other transactions, are subject to many risk factors. In addition to factors such as the economic conditions and political situation of the country holding the currency, there are also some influencing factors during the transaction process.

A. Leveraged Trading

The biggest risk of foreign exchange trading lies in its leveraged trading model. Retail investors are allowed to enter the market with a lower investment amount and conduct high-multiple foreign exchange transactions. Although once a profit is made, the rate of return is very considerable, the risk also increases proportionally, and investors may even lose all their initial capital. Learning how to manage risks is particularly important for foreign exchange trading.

B. Transaction Object

In the foreign exchange market, the currency pairs traded by investors are traded with their brokers, which means that the investor’s counterparty is the broker. The main risk caused by this is that once the broker goes bankrupt, the subsequent redemption of profits will not be completed. Therefore, investors should not only ensure that they cooperate with licensed and regulated brokers, but also consider the financial strength of the broker.

C. Compared with stocks

Foreign exchange trading hours are uninterrupted 24 hours a day, which means that unless investors have sufficient risk management capabilities or close their positions at the end of the transaction, their assets may be affected by the market at any rest time. This does not exist in the stock market with fixed trading hours.

In terms of market volatility, foreign exchange is affected by far more factors than the stock market, which leads to its volatility being also greater than the stock market. Greater volatility can be a good thing or a bad thing for trading.

In terms of market transparency, because foreign exchange is a global market and there is no specific institution to enforce information disclosure, the transparency of the foreign exchange market is not as good as that of the stock market. As a result, it is more likely for fraudsters to appear in the foreign exchange market and cause investors to suffer unexpected losses with false information.

In terms of risk diversification, foreign exchange has certain advantages over stocks. Due to the high liquidity of foreign exchange, it is unlikely that there will be situations such as being unable to sell in the stock market. Once the risk is detected, operations can be executed immediately to stop the loss.

Frequently asked questions

Question 1: What is foreign exchange trading?

Foreign exchange is called Forex Trading or Foreign Exchange in English. However, the two translations have different meanings.
Foreign Exchange is the basic function of foreign exchange. It is the process of exchanging one currency for another for various reasons. It generally involves the exchange of physical currency.
Forex Trading is a name in the financial field. During the transaction, the purpose is generally not to exchange physical currency, but to make a profit by predicting the exchange rate. The place where foreign exchange transactions are conducted is called the foreign exchange market.
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Question 2: What are the foreign exchange trading platforms?

Online brokers that can conduct foreign exchange trading in the United States include Interactive Broker, TD Ameritrade, and Ally Inves, as well as several other well-known brokers or banks, such as IG, Saxo Bank, and CMC Markets.
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Question 3: What are the foreign exchange trading hours?

In the United States, investors mainly trade from 5 pm EST on Sunday to 4 pm EST on Friday.
However, since the foreign exchange market is open 24 hours a day, investors cannot trade 24 hours a day.
This means that there may also be differences in foreign exchange prices between the close of Friday and the open of Sunday. Investors need to pay attention to the foreign exchange trading hours on weekends and change their positions accordingly.
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Question 4: Is foreign exchange trading risky?

Foreign exchange transactions, like any other transactions, are subject to many risk factors. In addition to the economic and political conditions of the country holding the currency, there are also some influencing factors in the transaction process.
The biggest risk of foreign exchange transactions lies in its leveraged trading model. Retail investors are allowed to enter the market with a lower investment amount and conduct high-multiple foreign exchange transactions. Although once a profit is made, the rate of return is very considerable, the risk also increases in the same proportion, and even investors may lose all their initial funds.
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