What Is Forex?
Forex is a term you may have heard before and whether you are aware of it or not, you have probably taken part in it if you ever traveled abroad and bought a foreign currency, for example. But have you ever stopped to think about what it actually means?
In this article, we delve into the details of Forex trading, from basic Forex terms traders should familiarise themselves with, to types of Forex pairs and more.
So if you want to know more about the world’s largest financial market, keep reading.
Forex Meaning Explained
In basic terms, Foreign Exchange or FX refers to the purchase of one currency against another, but its value is much deeper than that. The Forex market is the world's largest financial market. It is also the most liquid market with an average daily trading volume that exceeds trillions of dollars (as of November 2023), making it one of the most actively traded markets in the world.
Who Takes Part in the Forex Market?
Besides individual investors and traders, the Forex market may interest the following categories:
Central Banks like the Federal Reserve (FOMC), the Bank of England (BoE), and the People’s Bank of China (PBOC), are financial institutions responsible for overseeing and determining a country’s monetary policy and therefore play a pivotal role in the Forex markets.
For example, Central Banks directly influence currency rates through their monetary policies, set exchange rates, and use interventions to stabilize or improve their country’s economic strength and national currency’s competitiveness.
Multinational corporations usually engage in the Forex market by trading currencies during international transactions (international trades). This involves swapping currencies or making spot market purchases to mitigate risks associated with foreign exchange fluctuations, ensuring the stability of offshore investments.
Commercial and Investment Banks
Banks serve as the epicenter of currency trading as they engage in a multitude of activities, including executing client transactions, capitalizing on bid-ask spreads for profitability, undertaking speculative trades, and providing opportunities for portfolio diversification.
What Is Forex Trading Used For?
Forex trading can be used for multiple reasons some of the main ones include making a potential profit, speculation, and hedging:
- To Speculate: While higher interest rates, market volatility, and geopolitical tensions can be harmful to many traders, in some cases it can be helpful for Forex traders who aim to capitalise on these market swings through speculation.
- To Hedge: In simple terms, hedging refers to the practice of investing or trading a security to minimize the impact of potential price fluctuations, hence serving as a risk-management tool. Accordingly, businesses engaging in international transactions can be prone to currency fluctuations and might use hedging via Forex to fix a currency rate and minimize the risk of adverse currency value changes.
What Types of Forex Markets Are Available?
In the world of forex, there are 6 primary markets:
- Spot Forex Market – The physical exchange of a currency pair, taking place on the spot date (generally, this refers to the day of the trade plus 2 days - “T+2”). The spot market involves an immediate exchange of currency between purchasers and brokers. Banks, both central and commercial, and dealers are the main participants in the Spot Forex Market.
- Forward Forex Market – An Over Counter (OTC) contract to Buy or Sell a set amount of a currency at a certain price at a future date. This type of market can be very efficient for traders who are looking to hedge by selling their assets at a fixed price in order to avert possible future losses.
- Forex Futures Market – The main difference between the spot market and futures market is that futures are legally binding. A forex futures contract is an exchange-traded contract to Buy or Sell a specified amount of a given currency at a predetermined price on a set date in the future. Moreover, this type of market is known for its high liquidity.
- Swap Forex Market – It is essentially a transaction (a simultaneous purchase and sale) of Forex pairs in which the parties grant one another an equivalent amount of money using different currencies.
- Option Forex Market – Options are contracts whereby the seller gives the right, but not the obligation, to the buyer to buy or sell a Forex pair at a predetermined price. Using a call or a put option allows you to either buy or sell the pair accordingly.
- CFDs Market – A CFD, or a contract for difference, is an agreement between a buyer and seller, or a client and a provider like Plus500. The contract stipulates that the buyer is obligated to pay the seller the price difference of the underlying asset’s current value in comparison to its value when the contract was initiated.
- Majors - Major Currency Pairs are considered the most traded currencies worldwide, hence the name ‘major.’ Furthermore, this type of currency pair has the highest liquidity and always involves the U.S. Dollar (USD) being traded against other major currencies, namely the Euro (EUR), the British Pound (GBP) the Swiss Franc (CHF), the Japanese Yen (JPY), the Canadian Dollar (CAD), the Australian Dollar (AUD), and the New Zealand Dollar (NZD). The most traded Majors include the EUR/USD, AUD/USD, and USD/CAD.
- Minors - Minors are currency pairs that exclude the USD and usually have lower liquidity than the Majors. Examples of Minors are EUR/JPY, AUD/JPY, and GBP/EUR.
- Exotics - Exotics are usually considered the least traded as they are comprised of currencies that are harder to trade. An example of an Exotic pair is the GBP/SEK.
- Central banks – The world’s money supply is determined by central banks. If a central bank increases the money supply, the currency will likely drop. Generally, central banks also control interest rate levels, which is critical to the strength or weakness of a currency.
- Economic data – Reports on the state of the economy serve as an important indicator of the currency’s strength. Major economic data includes unemployment rates, inflation rates, and trade balances. Traders can utilise Plus500’s free Economic Calendar in order to help keep track of important economic events.
- Interest rates – Volatile currency moves tend to occur when a country’s central bank makes an unexpected move in interest rates. For example, if a central bank decides to unexpectedly cut interest rates in the currency, this will normally lead to a significant drop in value (as the market responds to the sudden change in monetary policy).
- Pip – The lowest increment in which a currency pair is priced.
- Spread – The difference between the Buy/Sell (Bid/Ask) price for a currency pair.
- Leverage – Allows you to trade higher amounts with less capital, which means that any potential profits or losses will be multiplied. Thus, a leverage of 1:50 means you would need $200 to place a $10,000 trade.
- Exchange Rate – The value of a base currency against a quoted currency.
- Bid – The price at which the market maker/broker is willing to buy the currency pair.
- Ask – The “offer” price used and offered by traders when they intend to buy an asset. Thus, usually this price should be higher than the market’s price.
- EUR/USD – This is the most widely-traded pair with the highest volume and deepest liquidity.The EUR/USD is called ‘Fibre’, which is a term that emerged with the Euro’s launch.
- GBP/USD – This is a popular currency pair that tends to be more volatile than EUR/USD. Volatility in GBP/USD has been higher in recent times due to the effects of “Brexit” (Britain's exit from the EU) and the economic uncertainty this has created. Furthermore, this pair is commonly named ‘Cable’, a term that originated in the mid-19th century. This is because the USD and the GBP were exchanged through a submarine communications cable.
- USD/JPY – This is the second most traded currency pair by volume behind the EUR/USD. It experiences high volume due to the size of Japan’s economy and its role in global economic trade. Due to its geographical location, trade in JPY can also reflect economic and geopolitical conditions in the wider Asian region. Moreover, this currency pair is known as trading the ‘Ninja’, due to the fact that the Ninja originated in Japan, the home of the JPY.
- Keep an eye on the past. Go back to the movements of the currency pairs in the past in order to try to jump the trend or get an overall vision of the possible moves this pair has in store. However, remember that while reviewing past trends can be useful to your trading strategy, it is not necessarily an indicator of future performance.
- You could test your strategy either with a popular FX pair or with your local currency against the USD, on our free, unlimited Demo Account, and keep in mind the trends and movements of the pair you want to trade.
- Always be cautious and diligent in your trades, and open small trades initially to carefully observe how the market is performing over time.
Where Can I Trade Forex CFDs?
For traders interested in accessing the Forex markets through leveraged trading*, Plus500’s Forex Contracts for Difference (CFDs) may be suitable.
While there are many Forex trading platforms, on Plus500, for example, you can trade CFDs on Forex on over 60* different Forex currency pairs, and a multitude of financial instruments. You can read more on the Plus500 website, and watch Plus500’s Trader’s Guide videos to learn about CFD trading with Plus500.
*Leveraged trading carries risk if adverse price swings materialize.
When Can I Trade Forex?
The Forex markets are open 24 hours a day, 5 days a week, and on Plus500’s trading platform, traders can access 24-hour CFD trading on FX pairs, opening at 08:00 Sydney time on Monday morning, and running through to 16:00 New York time on Friday afternoon.
Types of Forex Currency Pairs
As mentioned above, forex is the trading of currency pairs, and can be defined as the simultaneous purchase of one currency against another. Forex takes place mainly on the OTC market; however, it is also traded on futures exchanges.
Currency pairs generally fall into 3 main categories: Majors, Minors, and Exotics.
FX movements can reflect a number of different fundamentals including economic growth, international trade flows, and changes in interest rates.
How to Read a Currency Pair
As popular as the Forex market is, its popularity and its liquidity should not deter you away from learning how to read a currency pair and understanding how the Forex market works in order to make informed trading decisions.
Trading Forex pairs is fundamentally the buying of one currency and the selling of another. The first currency is known as the ‘Base’ and the second currency is known as the ‘Quote’. For instance, if you were to buy the EUR/USD currency pair, it means you are buying euros while selling dollars. Should the euro strengthen against the dollar, then you would make a profit. Conversely, should the euro fall against the dollar, then you would lose money.
The exchange rate is reflected in the quote currency. So, if the EUR/USD is trading at a rate of 1.1322, it means that 1,000 euros can be exchanged for 1,132.20 dollars.
In simpler terms, when trading the EUR/USD, for example, you are essentially asking yourself “how many US dollars does it take to purchase 1 euro?”. Likewise, when trading the EUR/JPY, you are purchasing the Euro, and in doing so, asking yourself the question “how many Japanese yen does it take to purchase 1 Euro?”.
What Moves the Forex Market?
There are many different factors that can affect the forex market. Below you can find a few:
A distinct example of how economic changes can impact currencies is the U.S. Dollar Index’s five day rising streak due to the possibility of higher inflation and Fed’s bond-purchasing program in November of 2021. This is due to the fact that the U.S. dollar is highly sensitive to inflation. By default, this affects any Forex pair that includes the U.S. dollar in it.
Of course, this is not as straightforward in practice. You need to integrate a variety of indicators and take the quote currency into account as well. Plus, timing is extremely important. Nevertheless, you can facilitate this process by using charting tools and an economic calendar for indications of when to open or close a trade, that are available on the Plus500 platform.
To read more about the events and factors that move Forex pairs, click here.
Key Forex Definitions
As previously mentioned, it is crucial for traders to know the basics of Forex trading. Since the Forex market is known for its magnitude, it is impossible to cover all the terms related to it in one article. Nevertheless, the following terms are some of the most important forex-related definitions that you should familiarise yourself with when trading online:
You can read more about important Forex terminology in our “Popular Forex Terms You Should Know” article.
Popular Forex Pairs Trading Pairs Examples
The bulk of FX trading is priced against the USD, which has long been regarded as the world’s official base currency. As mentioned above, all Major Currency Pairs (or Majors) are traded against the USD, and are generally regarded as the most popular currency pairs to trade. Many Cross-Currency Pairs (or Crosses) also experience heavy trading flows including EUR/CHF, EUR/GBP, and AUD/JPY - to mention a few.
In general, the top traded currency pairs are:
In short, Crosses are currency pairs that do not involve the USD, such as EUR/GBP, AUD/NZD and EUR/CHF. Exotics are major currencies paired against a smaller, less liquid economy, such as EUR/TRY* (Euro to Turkish Lira) or USD/MXN* (US Dollar to Mexican Peso).
You can explore more major Forex pairs in our “Most Popular Forex Pairs” article.
How to Choose the Best Currency Pair to Trade?
The world of Forex comes with a myriad of Forex pairs to trade. While the freedom of choice and endless possibilities can help diversify your profile, this can also lead to an overwhelming trading experience. Therefore, before choosing to trade Forex, you must be mindful of your trading strategies, market moves, and other factors that might affect your position.
While there are many ways to choose the best currency pairs to trade, here are a few short examples you can follow when choosing a currency pair to trade:
Plus500 offers CFD trading on the world’s leading currency pairs. Our user-friendly yet advanced online CFD platform includes a free demo account, a wide variety of educational resources, and trading tools that are made available to new and experienced traders alike. Our spreads are among the lowest in the industry and the intuitive platform is designed for ease of use, without compromising on in-depth analytical insights and sophisticated trading options.
How does Forex trading work?
Forex trading is essentially the act of speculating on foreign exchange currency prices with the hopes of making a profit.
What is the difference between Forex and stock trading?
The main and obvious difference between the two types of trading is that the former involves dealing with foreign currencies while the latter refers to trading a company’s shares. Additionally, whereas Forex markets are virtually open 24 hours a day, 5 days a week, the stock market’s trading hours are not as flexible and depend on the stock exchange trading hours. Other discrepancies may include the trading strategies used in each market and the volatility and the fact that the Forex markets are considered more liquid than the stock market.
How can I manage risk in Forex trading?
To effectively navigate the risks associated with Forex trading, it's essential to enhance your understanding of the Forex market by delving into its intricacies. As such, you may want to expand your knowledge about its nuances which will help you adopt a more informed trading approach. Moreover, you may want to consider building a trading plan that aligns with your financial goals and risk tolerance. Finally, you may want to use Plus500’s free risk management tools to your advantage in order to mitigate risks and protect further capital loss.
How can I start trading Forex?
To trade Forex CFDs with Plus500, you need to open a trading account. To do so, check out our “Opening an Account” section. Afterward, log into your Plus500 account → select the Forex category from the Plus500 platform, or type the name of your preferred Forex pair in the search bar → open a buy or sell position depending on your predictions and goals.
What is leverage in Forex?
Leverage can be a double-edged sword. On the one hand, it can help you multiply your gains if the price of the underlying asset goes along with your predictions. On the other hand, it can multiply your losses if the prices go against your predictions. You can read more about leveraged trading in our “What Does Leverage Mean?” FAQ.
* Instrument availability varies by operator.
** Please note that while this article aims to provide general information, it doesn't take into account your personal circumstances.