What is Forex?
What is Forex trading? Short for 'foreign exchange', this style of trading involves swapping different currencies against each other to (hopefully) turn a profit. Obviously there’s more to it than that – and in this article, we’re diving into it.
Author - TradeZella Team
Over the past few years, forex (FX) has become one of the most popular types of trading. And, just like stock day trading and cryptocurrency, more people discovered this hobby during the pandemic. The stats speak for themselves, with the Bank for International Settlements (BIS) last triennial survey showing that Global FX trading surged by 14% between 2019 and 2022.
By April last year, the market reached record highs of $7.5 trillion per day1.
The popularity of forex isn’t just statistics, either. It’s almost impossible these days to escape the social media influencers who claim to have made millions on the forex market. While it can be tempting to try and follow in their footsteps, it’s important to understand exactly what forex trading is first.
In this article, we’re going to go through all the things you need to know to decide whether this style of trading is right for you. We’ll also offer a few quick tips to help you become a better Forex trader.
Let’s start with the basics: what is the forex market?
The forex market is the largest financial market in the world. It’s where the exchange rate for different currencies is determined. This market rarely sleeps – trading goes on 24 hours a day, breaking only at the weekend.
The forex market has no central marketplace: instead, it’s over-the-counter (OTC). This means trades are made through computer networks, directly between different buyers and sellers.
As well as individual retail investors, the Forex market is also home to hedge fund managers, investors, companies, specialist forex dealers and central banks.
You’ll also find businesses that are there for more practical reasons. They’re not there to make money on trades or speculate, but to convert currencies for big international settlements and investments.
How does the forex market work?
What are currency pairs in Forex?
Foreign exchange always involves two currencies which form a ‘pair’. This is because you’re trading them against each other.
If that sounds complicated, remember you’ve probably already taken part in forex trading without realizing it. For example, if you’ve ever changed US dollars into Mexican pesos for a trip to Cancún. In this case, your pair would be USD/MXN.
With forex trading, something as every day as changing your cash for a vacation becomes an opportunity to make money. Let’s say that you paid one dollar for every 17 pesos before your flight, and then while you’re in Mexico the value of the dollar drops. When you change your MXN back to USD, you’ll make a small profit on whatever cash you have left.
Forex works like that: except you don’t need to go on vacation, and you don’t have to rely on random luck. With Forex trading you carefully choose your currency pairs based on what you think is going to be strongest. You then convert one currency into the other, and wait for the pips to start moving.
Speaking of pips…
What is ‘pip’ in Forex?
‘Pip’ – meaning ‘percentage in point’ or ‘price interest point’ – is the smallest whole unit price move that a currency exchange rate can make. It’s important to know what pips are because this is how traders measure bid-ask spreads for forex quotes.
Most currencies are priced to four decimal places, which means a pip is the fourth decimal place. So one pip would be equal to 0.0001 of your chosen currency. One notable exception is Japanese Yen (JPY). In these pairs, the pip is quoted at two decimal places (0.01).
Pips are different from basis points – bps – which are used in interest rate markets. These are usually more valuable than pips, as they represent a hundredth (0.01) while pips represent a ten thousandth.
You might also hear people talking about pipettes, which are fractional pips. They sit a decimal place further than a pip and a more accurate way of gauging a currency’s value. In most pairs, the pipette sits at the fifth decimal place (0.00001) and in JPY pairs it’s the third decimal (0.001).
But you don’t need to worry too much about them.
What is volatility in Forex?
Some currencies fluctuate in value more than others. In Forex, you want to look at this fluctuation against the currency you’re trading with. Measuring volatility in currency pairs means looking at how dramatic and regular the upswings and downswings are, and how much of a difference in value it results in.
If the value of the currencies swings wildly, the pair is volatile and likely to be a high risk, high reward prospect. If the value of the currencies you’re looking at tend to stay quite similar, the pair has low volatility – and is likely to be a fairly predictable bet.
If you’re using a trading journal – which you should be – make a note before opening your trade about how volatile the pair is. Taking this into account when you’re calculating your stop loss level and position size will help to minimize your risk.
What are the driving forces behind the forex market?
Whether you’re trading stocks, crypto or forex, it’s important to understand the factors behind the market. This can help you to make more informed decisions about which currency pairs to invest in.
So, when you’re doing your research about which pairs to work with, key things to look out for include:
- Macroeconomic events: things like inflation have a knock-on effect on a currency’s exchange rate
- Trade deficits and surpluses: these also have a big influence on the forex market
- Stock, bond and commodity markets: the success of these markets can influence the power of a currency
- Political news: surprising events can send currency up or down. For example, the result of the UK’s Brexit referendum in 2016 caused GBP to fall significantly2.
Where can I trade forex?
It’s not hard to find somewhere to trade forex. Lots of popular brokers offer Forex trading: for example, you can trade Forex on Thinkorswim.
If you already have a preferred broker, look around their platform to check if they have Forex trading available. If not, you’ll need to find a dedicated Forex broker or switch to an app that offers more asset classes.
When you’re choosing a Forex broker, some questions to ask yourself are:
- Is the broker regulated and trusted?
- Is their platform easy to use?
- Is the platform available in my country?
- Does it have good educational resources to support newbies?
- Does it integrate with my journaling software?
You can find a list of Forex brokers supported by TradeZella on our broker integration page. If you use one of them, your trades will sync automatically into your TradeZella journal. This means you don’t have to spend time downloading and uploading .csv files. All you need to do is get on with recording the information that really matters.
What is leverage in Forex trading?
‘Leverage’ is when you borrow capital (money) from a broker to make a bigger investment. It’s a common practice in Forex trading, but it can be really risky if you don’t know what you’re doing – so be careful!
You start by putting up a margin – your own cash – and choosing your leverage ratio. So, let’s say you have $1,000 of your own money to put forward and wanted to use a ratio of 100:1. This would give you $100,000 to invest.
The margin requirement is lower the higher the leverage ratio is. So a ratio of 50:1 requires a 2% margin, 100:1 requires at least 1%, and 200:1 requires just 0.5%
Leverage allows you to make a higher profit on successful trades, but it also means you can lose a lot more money on unsuccessful ones.
Remember: leverage is a loan, and it needs to be paid back. If the currency moves downwards instead of up, you could end up losing more of your own money than just your initial margin.
Making sure you have a stop-loss in place will ensure you don’t end up making catastrophic losses. But really, it’s best to avoid this style of trading unless you’re really confident in the trade you’re making, and really good at risk management.
Become a better Forex trader with TradeZella
Becoming a great forex trader doesn’t happen overnight. Like any other style of trading, it involves a lot of research, analysis and practice. It also involves self-reflection, and the ability to understand how and why you make mistakes – something we all do, especially when starting out.
This deeper level of understanding comes quicker if you use an analytics tool like a trading journal to analyze and reflect on every forex trade you make. You could use an automated spreadsheet or a pen and paper to keep a journal, but that can be time-consuming – and finding insights can take a while. Journaling software, like TradeZella, makes the process so much easier.
We’ve got a range of in-depth journaling features that can help build confidence, improve risk management and help you to recover after a loss. See your goals and KPIs at a glance on an analytics dashboard, and use advanced trade tracking to keep on top of the most important metrics. Personalized reports show you where you’re doing well, and where you have room for improvement.
You can even build out your trading plans and keep track of them in a dedicated Playbook.
Are you ready to up your forex trading game? Sign up for TradeZella today.