Currency trading, also known as forex trading (foreign exchange trading) and fx trading, involves the buying and selling of currencies to profit from changes in their exchange rates. The forex market is the largest and most liquid financial market in the world, with daily trading volumes exceeding $6 trillion. The forex market operates 24 hours a day, five days a week.
Currency trading is done in currency pairs, where one currency is bought while the other is sold. For example, in the currency pair EUR/USD, you’re buying euros (EUR) and selling U.S. dollars (USD). The value of a currency pair fluctuates based on economic factors, interest rates, geopolitical events, and market sentiment.
How Does Currency Trading Work?
Each curerncy pair consits of a base currency and a quote currency. The price of the pair indicates how much of the quote currency is needed to buy one unit of the base currency. For example, if the EUR/USD pair is trading at 1.20, it means that it would cost 1.20 USD to purchase 1 EUR.
Profits and losses are calculated using pip movements. One pip is the smallest price change a currency pair can make. Most major currency pairs are quoted to four decimal places, and a pip is typically 0.0001. The Japanese yen is a notable exception, because with this currency a pip is 0.01.
Trading Example
Let’s say you believe that the euro will strengthen against the U.S. dollar. You decide to buy the EUR/USD pair at 1.1500.
- If the exchange rate rises to 1.1700, you can sell your position for a profit.
- If the exchange rate falls to 1.1300, you would incur a loss if you closed your position.
Key Concepts in Currency Trading
Here are a few examples of key concept that you should learn more about before you start forex trading with real money.
Going Long vs. Going Short
If you believe the price of currency A will rise against currency B, you buy (go long) in currency A. If you believe the price of currency A will fall against currency B, you sell (go short) in currency A.
Pips
A pip is the smallest price move in the forex market. With most currencies, it represents a change in the fourth decimal place of a currency pair. For example, if EUR/USD moves from 1.1500 to 1.1501, that’s a 1 pip movement. The Japanese yen is an example of a currency that works differently, because here a 1 pip movement is a movement in the second decimal place.
Spread
Currency brokers typically make a bulk of their money from the spread. This is especially true for brokers that do no charge high commissions or other fees. The spread is the difference between the buy (ask) price and the sell (bid) price . For example, if EUR/USD has a buy price of 1.1500 and a sell price of 1.1498, the spread is 2 pips. Major pairs tend to have tighter spreads, while minor pairs and exotic pairs often have wider spreads due to lower liquidity.
Lot Size
Currency is traded in specific amounts called lots. The standard lot size in forex is 100,000 units of the base currency. There are also mini lots (10,000 units) and micro lots (1,000 units), which allow smaller trades with less capital. In the 21st century, many currency brokers online have begun to offer mini lots and micro lots to cater to small-scale hobby forex traders.
LeverageLeverage allows traders to control a large position with a relatively small amount of capital. For example, with 1:100 leverage, a trader can control $100,000 of currency with just $1,000 in capital. While leverage will amplify profits, it also amplifies losses, making proper risk management crucial.
Many of the stricter countries and financial authorities, such as ASIC, UK FCA, and CySEC, are limiting how much leverage a broker is allowed to give to a non-professional trader (retail trader). They also require brokers to give non-professional traders Negative Account Balance Protection, which means that the non-professional trader can not lose more money than what is in his or her trading account.
MarginMargin is the amount of money required to open a leveraged position. For example, if a broker offers leverage of 1:100, you only need to put down 1% of the total trade size as margin. So, to control a $100,000 position, you would need $1,000 in margin.
How To Get Started With Currency Trading
1.) Learn more about currency trading
Learn more about currency trading and how the currency markets work.
2.) Develop strategies
Use your knowledge to develop a basic trading strategy and risk management strategy. Since you are just starting out, focus on one currency pair and basic risk management. You can adjust your strategies later as you get more experienced and may want to branch out into more complex endevours.
Successful forex traders on all levels rely on well-thought-out trading strategies that outlines their goals, risk tolerance, and decision-making process. A strong plan includes points such as:
- Entry and exit points: Know when to enter and exit trades based on your analysis.
- Risk Management Orders: Use stop-loss and take-profit orders to manage risk and secure profits. A stop-loss order automatically closes your position if the market moves against you by a certain amount, limiting your potential loss.
- Position Sizing: Determine how much of your account balance you are willing to risk on each trade. Many traders recommend risking no more than 1-2% of your capital on a single trade. Also determine how much of your account balance that can be in open positions at any given time.
Select a currency pair based on your analysis or interest. Major pairs like EUR/USD, GBP/USD, and USD/JPY are commonly traded by retail traders because they have high liquidity and tighter spreads. You can also explore minor and exotic pairs based on your risk tolerance.
3.) Research brokers
Research brokers to find one that suits your trading strategy, needs and preferences. Look for brokers that offer points that are important to you, such as competitive spreads, low fees and commissions, access to the right currency pair or pairs, strong customer support, and suitable educational resources.
It is advisable to select among the ones that are authorized to be active in your country. Traders in countries where there is no specific reputable entity in charge of authorizing brokers will often pick a broker that is based and regulated in another country by an entity known for strict trader protection, e.g. in the United Kingdom (Financial Conduct Authority /FCA) or in Cyprus (Cyprus Securities and Exchange Commission /CySEC).
4.) Get and use a demo account
Sign up for a free demo account and use it to:
- Learn how the platform works.
- See if you like the platform and if is suitable for your strategy.
- Test out your trading strategies and risk management routines against real market data.
5.) Sing up with a broker
When you have found a broker that is right for you, and has tested the platform, it is time to sign-up and go through the Know Your Customer process where you verify your identity and provide the broker with some information about yourself and your trading experience.
Some brokers offer different types of accounts based on your experience level and the amount you want to deposit.
6.) Fund Your Account
Deposit funds into your account using a method such as bank transfer, credit card, or e-wallets.
7.) Start Trading
Once you’ve chosen your currency pair and performed your analysis, place your trade and monitor it..
8.) Keep a Trading Journal
Keep a trading journal and regularly evaluate your trading. Learn your strong points and weak points, and adjust your strategy as necessary. Only adjust trading strategies and risk management strategies when you are calm and do not have open positions. If you keep changing plans in the heat of the moment, each time you feel like you want to carry out a trade that goes against the plan, you are likely to fail.
Analyzing the Market
There are two main types of analysis used in currency trading:
- Technical Analysis
This method involves studying charts and using indicators (like Moving Averages, RSI, or Fibonacci Retracements) to identify price patterns and predict future movements. You will be using historical market data to prect future movements. - Fundamental Analysis
This approach focuses on understanding the underlying economic, political, and financial factors that influence currency prices. Key elements include interest rates, employment data, GDP growth, and geopolitical events.
Why is Currency Trading So Popular?
- Liquidity: The forex market is extremely liquid, allowing traders to enter and exit positions easily, even with large trades. This liquidity ensures tight spreads and minimal slippage.
- 24-Hour Trading: Unlike stock markets, the forex market is open 24 hours a day, five days a week, providing flexibility for traders in different time zones and with different lifestyles.
- Leverage: Forex brokers typically offer leverage, which allows you to control large positions with a small amount of capital. This can increase potential profits but also increases the risk of significant losses.
- Low Transaction Costs: Trading forex typically has lower transaction costs compared to trading stocks or commodities, especially with major currency pairs that have tight spreads.
- Profit from Rising or Falling Markets: You can always go long or short in a particular currency by chosing the right currency pair. Unlike the stock market, is no need for actual short-selling on the forex market, because if you for instance think the USD will lose value against the EUR, you can purchase EUR and pay with USD.
Risks of Currency Trading
Currency trading is inherently risky and it is not advisable to risk money you can not afford to lose. Below, we will look at a few examples of risks that are important for forex traders to keep in mind.
Market Risk: Forex trading involves speculation, and predicting currency movements is challenging. The market is influenced by a wide range of factors, making it difficult to consistently make accurate predictions. Currency prices can be highly volatile, especially during times of economic uncertainty or geopolitical events. Sudden price movements can lead to large losses.
Leverage Risk: Leverage will amplify both profits and losses. It is important to really undestand how leverage works and have a proper risk management strategy in place.
Counterparty Risk: Trading forex involves dealing with brokers, and there’s always a risk that the broker may become insolvent or engage in unethical practices. It’s important to choose a well regulated and reputable broker. In some countries, traders and investors are also protectedby government-backed insurance that can compensate them (up to a limit) if a broker company fails to adhere to its obligations due to bankruptcy.
Questions and answers about currencies
Which is the most traded currency?
The most traded currency on the forex market is the USD.
Examples of factors that are contributing to this:
- The USD is the official currency of the United States, and the United States is the world´s largest economy and heavily involved in international trade.
- The USD is the primary reserve currency, and huge amounts of USD is held by central banks and commercial banks around thw world.
- Many commodities that are traded on the world market are priced in dollars.
These are currently the ten most heavily traded currency pairs in the world, and as you can see, the USD is included in all of them except one.
- EUR/USD (Euro/US dollar)
- USD/JPY (US dollar/Japanese yen)
- GBP/USD (British pound/US dollar)
- AUD/USD (Australian dollar/US dollar)
- USD/CAD (US dollar/Canadian dollar)
- USD/CNY (US dollar/Chinese renminbi)
- USD/CHF (US dollar/Swiss franc)
- USD/HKD (US dollar/Hong Kong dollar)
- EUR/GBP (euro/British pound sterling)
- USD/KRW (US dollar/South Korean won)
Which is the most traded currency pair?
The most traded currency pair is the EUR/USD, which on average accounts for roughly 24% of daily forex trades. The second currency pair in the list, the USD/JPY, only accounts for a bit more than 13%, so the EUR/USD is the biggest pair by a wide margin.
This is not surprising, as the United States and the European single market are the world´s two largest economies.
Many novice hobby forex traders start with this fx pair, as it comes with several advantages. Pretty much every fx broker offers EUR/USD trading and the extremely high liquidity for this pair helps keep spreads tight, thereby reducing trading costs for the trader. There is also a bit of increased competetion among brokers for this pair, since they know so many traders prefer it. For the trader, the high liquidity will decrease the risk of slippage – you are more likely to see your orders go through at exactly the price points you selected.
The relative value between the EUR and the USD is impacted by numerous factors, including the interest rates set by the European Central Bank (ECB) and the US Federal Reserve (Fed), and official data released about the respective economy. Generally speaking, we can expect the currency with the higher interest rate to be in higher demand on the world market, which brings up the price. Example: If the ECB sets a higher interest rate than the Fed, we are likely to see the Euro rise in relation to the U.S. dollar.
What are commodity currencies?
Commodity currencies are currencies issued by countries with large commodity reserves. Examples of heavily traded commodity pairs are the ones where the USD is paired with the Canadian dollar (CAD), Australian dollar (AUD), or the New Zealand dollar (NZD). The Brazilian real (BRL) and the Saudi riyal (SAR) are two other examples of commodity currencies.
The price of a commodity currency in relation to the USD tend to be heavily influenced by the price of the commodity on the world market.
When the official currency of a country is a commodity currency, the economy of that country tend to be sensitive to changes in commodity prices, as the country typically relies heavily on commodity exports for its Gross Domestic Product.
Traders involved in trading commodity currency will therefore normally keep a keen eye on commodity prices and factors that may impact the prices of relevant commodities on the world market.
What are exotic currency pairs?
Exotic currency pairs are currency pairs that are neither major currency pairs nor minor currency pairs. They are less heavily traded than both the majors and the minors, and they tend to have low liquidity and wider spreads.
If you are interested in trading one or more exotic currency pairs, your selection of available brokers may be smaller, especially if you are looking for something really unusual.