What is forex trading? In its most basic form, this marketplace requires traders to speculate on the future price of a currency pair – such as EUR/GBP or GBP/USD. When speculating correctly, the trader will be able to cash their forex position out at a profit.
The purpose of this beginner’s guide is to fully explore the question – What is forex trading and how does it work?
We do so by explaining the key components of forex trading in a simple and user-friendly way so that first-time currency traders can assess whether this marketplace is suitable.
Your capital is at risk. 78% of retail investor accounts lose money when trading CFDs with this provider.
How Does Forex Trading Work?
Trillions of dollars worth of currencies change hands each and every day. The vast bulk of this marketplace is dominated by large banks and financial institutions. This is what drives the market in terms of demand and supply. However, it should be noted that macroeconomic and geopolitical events can also influence the direction of a currency pair.
For example, with prolonged concerns of an impending global recession, demand for the US dollar is at record levels. This means that the dollar is increasing in strength against most other currencies. For example, the euro recently went below parity with the US dollar. This means that for the first time, 1 US dollar was worth more than 1 euro.
It is events such as this that enable investors of all shapes and sizes to capitalize on ever-fluctuating currency price movements. The tricky part is knowing which way a particular currency pair will move. Most seasoned forex traders will ascertain the direction of a currency pair through technical analysis and high-level chart evaluation.
Such traders will look at historical trends and how they compare to current pricing levels. In order to achieve this goal, experienced traders will utilize economic indicators – such as the RSI, MACD, moving averages, Bollinger Bands, and more. These indicators assess a range of data in real-time surrounding volatility, support/resistance levels, and volume.
Forex Trading Explained in Layman’s Terms
There are many factors to have a strong grasp of when learning the fundamentals of what is forex trading. This includes everything from currency pairs and pips to leverage and order types.
Below, we help clear the mist by answering the following question in layman’s terms – what is forex trading all about?
Before getting started with a forex trading account, it is wise to understand the ins and outs of how currency pairs work.
- As noted above, each pair will contain two different currencies. – such as GBP/USD.
- In this example, the British pound is the base currency.
- The US dollar, on the other hand, is the quote currency.
- This means that a price of 1.1670 on GBP/USD would mean that for every £1 traded, $1.1670 will be returned.
As a newbie, it is best to focus on major currency pairs. This is because majors attract the largest levels of liquidity in the forex market. After all, each major pair will contain the US dollar alongside another strong currency.
Minors still consist of two strong currencies – such as the euro and the Canadian dollar. However, as the US dollar – which is the global reserve currency, is not present, liquidity levels are lower when compared to majors.
Liquidity is an important concept to understand when learning about forex trading. The reason for this is that the more liquidity associated with a particular forex pair, the less volatile it is. Moreover, major forex pairs offer the most attractive spreads – which we explain in more detail shortly.
In addition to majors and minors, forex brokers often offer access to exotic pairs. This enables traders to speculate on the future value of currencies from smaller economies, such as Turkey (TRY), South Africa (ZAR), and Argentina (ARS). Do note, however, exotic pairs can be super volatile.
For example, in just one year of trading, USD/TRY has gone from $8.28 to $18.21. This means that against the US dollar, the Turkish lira has dropped in value by more than 54%.
What is a Pip in forex trading? Percentage in point, or simply pip, refers to the last decimal point of a forex pair quote. Across all pairs – other than the Japanese yen, this is usually four digitals after the decimal point.
- For example, a movement from 1.5000 to 1.5002 would represent an increase of 2 pips.
- Or, a movement of 1.7950 to 1.7946 would represent a decrease of 4 pips.
Some forex brokers offer five units after the decimal point, which enables traders to enter smaller stakes.
In the case of the Japanese yen, brokers typically offer quotes of two or three units after the decimal point. For instance, USD/JPY might be shown as 139.55 or 139.558.
Essentially, a pip amounts to 1/100th of 1%. In some trading spheres, this is discussed as a basic percentage point.
Another term that beginner forex traders will come across is the spread. This refers to the difference between the bid and ask price of the currency pair being traded.
That is to say, when trading forex online, each pair will have two different prices attached to it. In simple terms, the spread is essentially the markup that forex brokers make on each position entered.
Therefore, traders should opt for brokers that offer tight spreads, which will result in more cost-effective trading fees. With that said, spreads are often determined by the amount of liquidity in the market.
For instance, EUR/USD is the most traded currency pair globally, so this will often come hand-in-hand with competitive spreads of under 1 pip.
Exotic pairs, however, due to their extreme volatility, can often come with a spread that amounts to dozens of pips.
Here’s an example of how the spread can impact trading profits:
- Let’s say that the trader is looking to speculate on GBP/USD
- The forex broker being used is quoting a bid price of 1.1576
- The ask price on this pair is 1.1578
- This means that the spread is 2 pips
Now let’s say what happens after a trade is opened:
- The trader predicts that GBP/USD will rise
- Therefore, they will get a price of 1.1578
- However, in order to cash the position out, the trader would need to do so at a price of 1.1576
- This means that as soon as the trade is opened, the position is down by 2 pips
- As such, the trader would need to make gains of 2 pips to break even
Further down this guide on What is Forex Trading? – we discuss a selection of popular brokers that offer competitive spreads.
Once the trader has decided which forex pair they wish to speculate on, the next step is to create an order.
This will need to be a choice between a long or short order, which lets the broker know whether the trader believes the currency pair will rise or fall in value.
- When placing a long order, this means that the trader is buying the currency pair. As such, they believe the pair will rise in value.
- However, when placing a short order, the trader is selling the pair, and thus – they believe its price will fall in value.
There are order types that forex traders are advised to deploy when creating a position. For instance, the broker will require the trader to choose from a limit or market order.
A limit order enables the trader to select the price that they want the trade executed. For instance, if GBP/USD is at 1.1601, the trader might not want to enter a position until it hits 1.1630. The limit order will only be deployed when this price has been triggered.
A market order, on the other hand, instructs the broker to execute the position instantly. This will be carried out at the next best available price, which will likely be slightly higher or lower than the current quote.
Note: Any difference between the quote and execution price is known as slippage.
Although leverage can be a dangerous tool to use, without it, forex trading will be a challenging task for those on a budget. The reason for this is that currencies are traded in lots, which amount to 100,000 units of the base currency.
For example, when trading EUR/USD, the base currency is the euro. Therefore, large banks and financial institutions will trade this pair in lots – each of which is worth €100,000.
We briefly mentioned earlier that many online brokers support a minimum trade requirement of 0.01 lot. However, when trading EUR/USD, for example, this still requires a capital outlay of €1,000.
This is where leverage comes into play. In a nutshell, leverage enables the trader to enter a forex position worth more than they have in their brokerage account.
- For example, let’s say that the trader wishes to meet the minimum lot size of 0.01 on GBP/USD
- This would require a total stake of £1,000
- The trader decides to apply leverage of 10:1 on this position
- As such, although the trader is entering a position worth £1,000, they only need to risk 10% of this figure – or £100
Now, it should be noted that leverage comes with both pros and cons. On the one hand, the trader can access a much larger forex position when utilizing leverage – even if they have an account balance that is considered small.
However, leverage will also increase the risk of financial loss. In simplistic terms, of leverage of 10:1 is utilized, this means that the trader only needs to put 10% of the position size up front.
Equally, if the value of the trade declines by 10%, it is likely that the broker will liquidate the position. This would result in the trader losing their entire stake – sometimes more if the broker does not offer negative balance protection.
Note: Negative balance protection ensures that when leverage results in a losing position, the forex trader cannot lose more than they have in their account. Stop-loss orders can prevent unnecessary losses, which we explain in more detail shortly.
In terms of leverage limits, this often depends on three core factors:
- Retail clients will be offered much lower levels of leverage when compared to professional traders.
- Major pairs often come with the highest leverage limits when compared to minors and exotics
- Jurisdictional limits apply too. For instance, retail clients in the US can get leverage of up to 50:1 on major pairs. In the UK, Europe, and Australia – this is capped to 30:1.
Learn More: Read our comparison guide on the best high-leverage forex brokers.
Profit and Loss
Some forex traders will attempt to calculate profit and loss by the number of pips that a currency pair has moved.
However, the easiest way is to focus on the percentage gain or loss of the pair in question. This can then be multiplied by the stake and, if applicable, the level of leverage utilized on the position.
Let’s clear the mist on how to calculate profit and loss when trading forex through some examples:
- The trader is going long on USD/CAD at an entry price of 1.3160
- The position is worth $1,000 with leverage of 10:1- so the stake amounts to $100
- A few hours have passed and USD/CAD is now trading at 1.3423
- This represents an increase of 2%, so the trader closes the position
- On a position size of $1,000 – the trader makes 2% or $20
- The trader is going short on GBP/USD at an entry price of 1.1601
- The position is worth $50,000 with leverage of 50:1 – so the stake amounts to $1,000
- A few hours have passed and GBP/USD is now trading at 1.1484
- This represents a decrease of 1%, so the trader closes the position
- On a position size of $50,000 – the trader makes 1% or $500
Note: When leveraged forex positions are held overnight, this can incur an interest charge – otherwise known as a swap fee.
5 Popular Forex Pairs to Watch Right Now
In this section of our guide on What is Forex Trading? – we will explore some of the best currency pairs to trade in forex.
EUR/USD – which carries the nickname Chunnel, is the most traded forex pair globally. After all, this pair consists of the world’s two strongest and most in-demand currencies – the euro and the US dollar.
This makes EUR/USD one of the best forex pairs to trade, considering the sheer amount of liquidity that it attracts. This means less volatility and, ultimately – competitive spreads.
With that said, even EUR/USD is considered volatile in today’s uncertain economic climate. In Q3 2022, the unthinkable happened, whereby EUR/USD moved below parity. As of writing, this pair is trading at a small fraction over parity at 1.0014.
Formally the most traded pair globally, GBP/USD is nicknamed the Channel. This pair consists of the British pound and the US dollar, and it has been on the decline since the Brexit referendum in 2016.
Prior to the vote, GBP/USD was trading above 1.5000. As of writing, GBP/USD is trading at under 1.1600. This means that since 2016, the British pound has declined by over 22% against the US dollar.
USD/JPY, nicknamed the Gopher, is another heavily traded pair that historically, generates significant levels of liquidity. This pair consists of the US dollar and the Japanese yen as the base and quote currency, respectively.
Over the prior 12 months of trading, the yen has been on a downward spiral against the US dollar. USD/JPY has, therefore, declined by over 26% during this timeframe.
The economies of the UK and the European Single Market have been closely aligned for many years, even after the Brexit referendum of 2016.
This sentiment is supported by the price movement of GBP/EUR – which has remained pretty much stagnant over the prior 12 months of trading.
For instance, in the year prior to writing, GBP/EUR was trading at 1.1627. As of writing, the pair is trading at 1.1558. This represents a slight decrease of just 0.76%.
This currency pair is not for the fainthearted – as it represents the value of the Turkish lira against the US dollar. As we noted earlier, USD/TRY has declined by 54% in just 12 months of trading.
This is because the Turkish economy continues to supper from rising unemployment and ever-growing inflation levels. However, this volatility is often craved by seasoned currency speculators – due to the constant swing trading opportunities on offer.
Note: The pairs listed above can be traded with leverage at eToro with a minimum first-time deposit of $10.
Popular Strategies for Forex Trading
Is forex trading profitable? Well, forex trading is a highly competitive and complex battlefield that requires a solid understanding of how currency price movements are influenced.
Successful forex traders will also follow a set of risk-management strategies to ensure that gains are maximized and losses are capped.
Therefore, in this section of our guide on What is Forex Trading? – we explore popular strategies that beginners might consider incorporating.
Stop-Loss and Take-Profit Orders
The first thing to have a firm grasp of before trading forex for the first time is the value of stop-loss and take-profit orders. The vast majority of forex trading platforms offer these two order types – so this should be expected as a minimum.
In a nutshell, stop-loss orders allow traders to limit the losses of an unsuccessful trader.
For instance, the trader might wish to cap their potential losses to 3% of the position size. If the trade declines by 3%, the broker will automatically close the trade at a loss of 3%.
Here’s an example of how to deploy a stop-loss order:
- The trader goes long on GBP/EUR at an entry price of 1.1559
- The trader does not want to lose more than 1.5% on this position
- Therefore, they enter a stop-loss order at 1.5% below the entry price of 1.1559
- The stop-loss order price would need to be set at 1.1385
As per the above example, if GBP/EUR declines to 1.1385, the forex broker will close the position, and thus – the trader will cap their losses to 1.5%.
Take-profit orders, on the other hand, are deployed to lock in profits. The trader will simply need to determine the price that they wish to close the trade, and the broker will execute this if and when this level is triggered by the markets.
Here’s an example of how to deploy a take-profit order:
- The trader goes long on GBP/EUR at an entry price of 1.1559
- The trader wants to make a 4% profit on this position
- Therefore, they enter a take-profit order at 4% above the entry price of 1.1559
- The take-profit order price would need to be set at 1.2021
As per the above example, if GBP/EUR increases to 1.2021, the forex broker will close the position, and thus – the trader will lock in their target profit of 4%.
Another area of risk management that should be considered when learning how to start forex trading for the first time is with regard to the trader’s bankroll.
This refers to the amount of capital that the trader has in their brokerage account. A sensible bankroll strategy will determine the maximum amount of capital that can be risked on a single forex position.
- The trader deposits $5,000 into their forex broker account
- The trader sets a sentiment bankroll management limit of 2% per trade
- This means that the maximum trade position amounts to $100
The maximum stake size in dollars and cents will rise and fall in line with the trader’s balance.
For instance, let’s say that after closing a position, the trader’s bankroll now stands at $5,200. Sticking with the 2% cap, the maximum trade size has now increased to $104.
The main safety net with this forex trading strategy is that it ensures the trader does not burn through their entire bankroll. After all, as the bankroll declines, so will the maximum stake permitted.
Day traders will typically rely on technical analysis – which can take many months or years to master. In the meantime, a good starting point is to understand how fundamental news can impact the value of one or more currencies.
For example, after the previously mentioned Brexit referendum of 2016, the uncertainty that this brought to the UK economy meant that GBP rapidly declined in value against other major currencies.
Similarly, uncertainty in the global markets in the midst of the pandemic result in the US dollar becoming a safe haven for investors. This resulted in the value of USD increasing against most other currencies.
It goes without saying that the most successful forex traders utilize technical analysis. This refers to the process of analyzing pricing trends and charts, with the view of predicting short-term movements.
To facilitate a technical analysis strategy, traders will utilize indicators. Each indicator will assess a specific metric surrounding the relationship between two currencies, such as volume, volatility, and support/resistance levels.
For example, RSI (relative strength index) evaluates whether a currency pair is potentially overbought or oversold. If the pair is oversold as per the RSI reading, this means that the declining pair in question could see a temporary reversal. Another popular forex trading strategy is the Fibonacci sequence. But what exactly is Fibonacci in forex trading?
Those learning how to trade forex for the first time likely do not have any prior experience in deploying technical or fundamental analysis strategies. Therefore, it might be wise to look at whether any reliable third-party systems can assist.
A good starting point is to explore forex signals, which provide trading suggestions that are curated by seasoned currency analysts. Some of the best forex signals that we have come across are available at Learn2Trade.
This established provider offers up to five premium forex signals each and every day.
An example of what a Learn2Trade forex signal looks like can be found below:
- Pair – EUR/USD
- Position – Long
- Entry Price – 1.0010
- Stop-Loss Price – 0.9800
- Take-Profit Price – 1.2001
As per the above, those in the category of forex trading for beginners will have all of the information they need to go and place the suggested orders. Thus, there is no requirement to have any knowledge of technical analysis.
Another option for beginners to consider is the deployment of a forex trading bot. These are software programs that have the capacity to place buy and sell orders autonomously.
Risks of Forex Trading
Is forex trading worth it? Well, forex trading is no different from any other investment market, insofar that certain risks need to be considered before getting started.
The main risks of forex trading are as follows:
- Risk of Loss – Forex trading offers no guarantee of making money. On the contrary, the trader can lose some or even all of their initial deposit.
- Volatility – Some forex pairs – especially exotics, can be extremely volatile. Beginners might, therefore, be best to stick with major pairs when trading forex for the first time.
- Delayed Pricing – Some forex brokers are notorious for supplying delayed market data. This means that by using such a broker, the trader will constantly be behind the rest of the market.
- Negative Balance – Is forex legit? Most, but not all, forex brokers offer negative balance protection. By using a provider that doesn’t offer this safeguard, an unsuccessful position can result in the trader owing money to the broker.
- Leverage – Major forex pairs permit the largest levels of leverage when compared to other asset classes. This can result in an overuse of leverage, which, when trades are unsuccessful, will amplify losses
As we explained earlier, by incorporating risk-management strategies with sensible stop-loss orders, the risks of trading forex can be reduced.
Where to Start Forex Trading – Popular Forex Trading Brokers Reviewed
What is a forex broker? Well, the only way to trade forex as a beginner is to register with a regulated broker that offers a combination of low fees and small account minimums.
Moreover, when choosing a forex broker, traders should look at how user-friendly the platform is and whether it offers any educational and research tools.
Below, we review a selection of popular forex brokers that accept account applications from retail traders.
1. eToro – Low-Cost Forex Broker With Copy Trading tools
eToro is one of the best forex brokers for beginners. The platform requires a minimum first-time deposit of $10, albeit, in some countries, this is slightly higher at $50. Nonetheless, it takes just minutes to open an account and deposit funds, with the platform supporting debit/credit cards, e-wallets, and bank transfers.
No deposit fees are charged by eToro when the payment is made in US dollars. Otherwise, there will be an FX fee of 0.5% charged on the deposit. eToro supports 49 currency pairs, most of which are from the major and minor markets. A small number of exotics are supported too, although these should be avoided as a beginner.
When it comes to forex trading fees, eToro operates on a spread-only basis. EUR/USD, for instance, starts at 1 pip per slide. eToro offers leverage of up to 1:30 to retail clients when trading major pairs, and 1:20 on minors and exotics. The minimum trade size when applying leverage of 1:30 amounts to $33.33.
eToro offers real-time pricing charts for all of the forex pairs that it supports. For those with prior experience, there is access to technical indicators and drawing tools. eToro also offers market insights, webinars, financial news, and access to educational materials. Perhaps even more important for beginners is that eToro offers demo accounts.
It takes just seconds to switch over to demo mode, which enables traders to practice their forex strategies with a pre-loaded paper balance of $100k. Being one of the best copy trading platforms out there, another feature that might be of interest to newbies is the Copy Trading tool. This enables eToro users to copy the buy and sell positions of a seasoned forex trader. Hence, this promotes a passive trading experience.
In addition to forex, eToro also enables users to invest in cryptocurrency. It is also possible to trade commodities and indices and invest in thousands of commission-free stocks and ETFs. eToro also offers a mobile app for iOS and Android devices, which enables users to trade forex on the go.
eToro is regulated by multiple bodies – including the FCA, ASIC, CySEC, and SEC. Learn more about what this leading copy trading broker has to offer by reading our eToro review.
|No. Forex Pairs for Copy Trading||49|
|EUR/USD Spread||1 pip|
|Max Leverage||1:30 for retail clients|
|Deposit Fee||Free on USD deposits, otherwise 0.5%|
|Inactivity Fee||$10 after 12 months of inactivity|
78% of retail investor accounts lose money when trading CFDs with this provider.
This guide on What is Forex Trading has explained the core basics of what it takes to begin speculating on currencies today.
We have covered many important forex principles, such as pairs, pips, leverage, spreads, and technical analysis. This is to ensure that beginners have the required tools to begin trading forex in a risk-averse manner.
Those wishing to get started right now might consider eToro, not least because the platform requires a fee-free minimum deposit of just $10 – alongside a fully-fledged demo account.
Moreover, eToro supports commission-free trading across 49 currency pairs.
Your capital is at risk. 78% of retail investor accounts lose money when trading CFDs with this provider.