Foreign exchange trading is also known as FX trading or forex trading. It provides the opportunity to speculate on price fluctuations within the FX market. The goal of FX trading is to forecast if one currency’s value will strengthen or weaken relative to another currency. A forex trader will encounter several trading opportunities each day, due to daily news releases.
FX traders take advantage of this by becoming extremely receptive to market news releases and then trade based upon the suspected market sentiment. FX is an industry term that is abbreviated from forex, and is commonly used instead of forex. However, forex is also an abbreviation of foreign exchange. Read more about forex news trading strategy.
How does forex trading work?
Forex is always traded in currency pairs – for example, GBP/USD (sterling v US dollar). You speculate on whether the price of one country’s currency will rise or fall against the currency of another country, and take a position accordingly. Looking at the GBP/USD currency pair, the first currency (GBP) is called the ‘base currency’ and the second currency (USD) is known as the ‘counter currency’.
When trading forex, you speculate on whether the price of the base currency will rise or fall against the counter currency. So in GBP/USD if you think GBP will rise against USD, you go long (buy) the currency pair. Alternatively, if you think GBP will fall against USD (or that USD will rise against GBP), you go short sell the currency pair. Find out what are some of the most traded currency pairs in the forex market by reading our in-depth guide.
What is leverage in forex trading?
When trading, forex leverage allows traders to control a larger exposure with less of their own funds. The difference between the total trade value and the trader’s margin requirement is usually ‘borrowed’ from the forex broker. Traders can usually get more leverage on forex than other financial instruments, meaning they can control a larger sum of money with a smaller deposit.
The availability of leverage is one of the reasons that many people are interested in trading FX via a forex spread betting or CFD trading account. CMC Markets’ accounts offer competitive margin rates on forex instruments starting at just 3.3%, or 30:1 leverage. This is higher leverage than the 20% margin rate (5:1 leverage) available for shares instruments. Read about other differences between forex vs stocks here.
What is spread in forex?
The spread in forex trading is the difference between the buy and sell price of an FX currency pair. When you trade forex pairs, you are presented with a ‘buy’ price that is often above the market price and a ‘sell’ price that is often below the market price. The difference between these two prices is referred to as the ‘bid-ask’, or ‘buy-sell’ spread.
Forex trading has some of the lowest spreads available of all financial instruments we offer, starting at just 0.7 points,
compared to a minimum spread of 37 points for bitcoin, or 3 points for crude oil. See a full list of our current forex trading spreads and margins.
How to trade the FOREX market
There are a many ways to trade on the forex market, all of which follow the previously mentioned principle of simultaneously buying and selling currencies. If you believe an FX ‘base currency’ will rise relative to the price of the ‘counter currency’, you may wish to ‘go long’ (buy) that currency pair. If you believe the opposite will happen and the market will fall, you may wish to ‘go short’ (sell) the currency pair.
The forex market was historically traded via a forex broker. However, with the rise of online trading companies, you can take a position on forex price movements with a spread betting or CFD trading account. Both spread betting and CFD trading accounts provide a form of derivative FX trading where you do not own the underlying asset, but rather speculate on its price movements. Derivative trading can provide opportunities to trade forex with leverage. As this can be a risky process, forex traders often choose to carry out forex hedging strategies, in order to offset any currency risk and subsequent losses. For more information on how to start forex trading from home, read our step-by-step guide here.
Forex trading strategies
Forex traders use FX trading strategies to guide their buying and selling activities, whether it be from an office or trading at home as a hobby. The ability to follow a strategy that informs a trader’s decisions is what differentiates trading from guesswork. Many traders create strategies by adopting elements from others’ trading strategies, but tailor the systems to meet their own specific needs.
A currency trading strategy often includes a number of forex signals and technical indicators. A forex trading signal can provide prompts to help determine entry and exit points for a given forex market. These signals can be determined by either manual or automated methods. Manual methods involve looking at chart patterns and averages to determine buy and sell opportunities. Automated methods use algorithms that determine trading signals and execute trades based on several pre-set conditions. Forex scalping can use either of these methods, where the aim of the trader is to enter and exit the market as quickly as possible, with the aim of making small but frequent profits.
You can use numerous trading strategies to inform your trading decisions. Forex trading strategies, like other trading strategies, can be based on a combination of technical analysis and fundamental analysis. Technical and fundamental analysis are very different, so a blend of the two can be used to develop a more balanced trading strategy.
Many popular forex trading strategies, such as those outlined in our forex trading strategies guide, are based on trading chart patterns and mathematical formulas. Bear in mind that our forex strategies guide is not a definitive list, and just outlines some popular technical methods some experienced traders use. Other traders will trade based on macroeconomic forex news. This ‘big picture’ news tends to influence forex markets to a greater degree than any other factors. For example, news that suggests rising interest rates without a rise in inflation could increase the likelihood of a rise in currency value. By contrast, falling interest rates can increase the ease and likelihood of lending, but can devalue a nation’s currency in the long-term. What influences the foreign exchange markets?
To trade the forex market with little awareness of the factors that influence the FX market can result in substantial losses. Many of the macroeconomic forces at play can have huge effects on the valuation of a currency.
When looking at forex markets, it’s important to remember that a stronger currency makes a country’s exports more expensive for other countries, while making imports cheaper. A weaker currency makes exports cheaper and imports more expensive, so foreign exchange rates play a significant part in determining the trading relationship between two countries.
Political instability and economic performance
Political instability and poor economic performance can also influence the value of a currency, such as when there are presidential elections and national recessions. Politically stable countries with robust economic performance will usually be more appealing to foreign investors, so these countries draw investment away from countries characterised by more economic or political risk.
Interest rates, inflation rates and foreign currency rates are all interconnected, and as some rise others can fall. Central banks control the interest rate as a measure to control inflation. If a central bank wants to decrease inflation, it can increase interest rates in a bid to stop spending and lending.
This generally increases the value of money in an economy, as there is less, or ‘more expensive’, money available in the economy.
On the other hand, when there is more money with less value in an economy, businesses and consumers increase spending and lending through loans and other types of credit. Sellers will then increase prices, causing inflation and a lower-valued currency. These fluctuations in currency value are one of the reasons forex traders may look to trade on interest rate announcements from central banks, like the US Federal Reserve or the Bank of England. This can be done through cross currency swaps, which can help to hedge currency risk on both interest rates and exchange rates.
Often paired with interest rates, inflation rates can have a major influence on a nation’s foreign exchange rates. Rising inflation rates often have a negative effect on a currency’s value. Conversely, low inflation rates usually cause an appreciation in the value of a currency. When inflation is high, the price of goods and services increases, which can cause the currency to depreciate, as there is less spending.
Terms of trade
The terms of trade for a country represent the ratio of export prices relative to import prices. If a country’s export prices
rise and its import prices fall, the terms of trade have favourably improved. This increases the nation’s revenue and is followed by an increase in demand for the country’s currency. This increase in demand can cause a rise in the currency’s value.
A nation’s debt can be a large influencer in the variations of its currency price. Countries with large debts in relation to their gross domestic product (GDP) will be less attractive to foreign investors. Without foreign investments, countries can struggle to build their foreign capital, leading to higher rates of inflation and thus, currency depreciation. Read more about economic indicators that can have an effect on forex.
What are the benefits of forex trading?
The ability to trade on forex margin (using leverage).
High levels of liquidity mean that forex spreads stay tight and trading costs stay low.
Prices react quickly to breaking news and economic announcements (this can be a disadvantage too).
Trade 24 hours a day from Sunday to Friday.
The ability to go long and short.
Wide range of markets (spread bet or trade CFDs on more than 330 forex pairs with CMC Markets).
Market trends can be more predictable.
What are the potential risks of forex trading?
You can lose all of your capital – leveraged forex trading means that both profits and losses are based on the full value of the position.
Risk of account close out – market volatility and rapid changes in price can cause the balance of your account to change quickly, and if you do not have sufficient funds in your account to cover these situations, there is a risk that your positions will be automatically closed by the platform.
Currency pair correlations can increase the interest rates outside of major forex pairs
Market volatility and gapping – financial markets may fluctuate rapidly and gapping is a risk that arises as a result of market volatility, and one of the effects of this may mean that stop-loss orders are executed at unfavourable prices.
Risk of carry trade.
Central bank decisions can have an effect on interest rate levels.
Forex trading is a fast-paced, exciting option and some traders will focus solely on trading this asset class. They may even choose to specialise in just a few select currency pairs, investing a lot of time in understanding the numerous economic and political factors that move those currencies.
Want to learn more about currency trading? Check out our forex trading for beginners guide, which includes a step-by-step guide on how to start forex trading. Robot & Auto Trading Robot