What is Forex Trading?

Find out about forex, the simultaneous exchange of different currencies on the market. Learn more about the largest and most liquid financial market in the world.

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What is currency trading?

Currency trading has soared in popularity this century amongst professional and non-professional traders alike. Before the arrival of the Contract for Difference (CFD) market in the late 1990s, currency trading was an asset class that was difficult for individuals to trade or invest.

Stock and share ownership had been growing throughout the latter 20th century, while ownership of bonds was possible via investment funds. However, currencies had traditionally been the realm of large institutions – unless you were changing up currency for a holiday abroad.

What we now call foreign exchange or currency trading is the interchange of one currency for another, and it is this exchange that separates currency trading from other markets.

When you trade currencies, you are anticipating that one currency will rise or fall relative to another one. Currency trading, therefore, is a “relative value” trade, by which we mean that you look for one currency to appreciate in value and for another currency to fall in value relative to the first.

So, when trading currencies, we need to decide which currency we expect to be rising in value, and which may depreciate in value – relative to one another.

Advantages of currency trading

It is wide-ranging, with opportunities to trade many different currencies against each other

It can be fast-moving and offering opportunities for traders to benefit from impulse price movements

An extremely liquid 24-hour market, open from Sunday - Friday

A brief history off foreign exchange

The history of the currency markets can be traced back to ancient Egypt and Greece, and even further back to Biblical times with money changers in the Holy Land. The Middle Ages saw currencies traded between international banks with the Medici family accounting book in the 15th Century. The Gold Standard Monetary System, the post-World War II Bretton Woods System, the Smithsonian Agreement and the Plaza Accord have all been stepping stones throughout the 19^th and 20^th centuries to the modern era of free-floating exchange rates that we now take for granted.

The modern currency trading markets and the major players

Today, the currency trading markets are the world’s largest traded asset class, with between $5-7 trillion of transactions each day of the trading week. The major players in these markets include

Investment banks
Commercial banks
Central banks
Multinational corporations
Institutional brokers

Between these powerhouses sit individual, professional, and retail traders looking to make a profit.

What factors impact currency trading markets?

A multitude of factors drives foreign exchange markets, but there are four main drivers:

Macroeconomic data — The economic health of the country that issues any currency can have a significant impact on the value of the currency. Generally speaking, the better the economic outlook for an economy, the stronger the currency and vice versa. Macroeconomic data can inform us of the current and future health of any economy.
Central banks — Central banks control monetary policy, which principally means they can lower and raise interest rates. If interest rates are expected to rise, the currency would probably appreciate, while anticipation of lower interest rates would likely point to a weakening currency.
Geopolitical events — Events such as war, trade conflicts, acts of God (such as earthquakes), political elections come under the broad banner of geopolitics. These can have notable influences on differing currencies.
Technical analysis — Technical analysis is the study of charts to make informed trading decisions. When currency pairs break certain technical analysis levels, called support and resistance, it sometimes causes the market to move more aggressively.

Popular currencies to trade

The most popular currencies in currency trading are those of the significant global economies where the Foreign Exchange rate is free-floating. These are commonly known as the majors”.

The main currency pairs that make up the majors would be combinations of:

US Dollar
Euro
Japanese Yen
GB Pound
Swiss Franc
Canadian Dollar
Australian Dollar

Each of these currencies traded against each other is deemed as the majors, so for example; EURUSD, USDJPY, GBPUSD, USDCHF, USDCAD, AUDUSD and NZDUSD.

Other currency trading opportunities

Outside of the majors, there are other ways of expressing a view via the currency markets. These would be via cross rates and emerging markets (EM) currencies.

Cross Rates are currencies where the US Dollar is not involved, so this could be Euro-GB Pound (EURGBP) or Australian Dollar to Japanese Yen (AUDJPY).
Emerging Market currencies would include the Brazilian Real (BRL), the Russian Ruble (RUB), the Indian Rupee (INR) and the Chinese Yuan (CNY).

An example of a currency trade

If you had an unfavourable view for the Euro, perhaps because you felt that the Eurozone economy was performing poorly and was going to continue as such, you might look to short the Euro.

You might also have a view that the UK economy was looking healthy and that the short-term data was going to reflect this and beat expectations.

In this case, you would look to express your view by selling the Euro and buying the GB Pound, which would be a short position on the EURGBP currency pair.

Let’s say you sold EURGBP at 0.8500, with a target for a move down to 0.8000. You might then place a stop loss at 0.8700 in case the currency pair moved in the opposite direction.