Forex Basics

The foreign exchange market — commonly referred to as forex or FX — is the global marketplace in which currencies are bought and sold. It is the largest and most liquid financial market in the world, with daily trading volume exceeding $7 trillion according to the Bank for International Settlements.

Unlike stock markets, which operate through centralised exchanges with set trading hours, the forex market is decentralised — it operates through a global network of banks, financial institutions, brokers, and individual traders connected electronically. This structure means the forex market is open 24 hours a day, five days a week, from the Sunday evening open in Sydney to the Friday evening close in New York.

Currency trading always involves two currencies — a base currency and a quote currency — presented as a pair. When you see EUR/USD quoted at 1.0850, this means one euro buys 1.0850 US dollars. The first currency listed (EUR) is the base; the second (USD) is the quote.

Trading forex means simultaneously buying one currency and selling another. If you believe the euro will strengthen against the dollar, you buy EUR/USD — you are buying euros and selling dollars. If the pair rises from 1.0850 to 1.0950, you have made a profit on that position.

Trades in the forex market are executed over the counter (OTC), meaning directly between parties — typically through a broker — rather than through a centralised exchange.

The forex market has several distinct categories of participant, each with different motivations and operating at different scales.

Central banks are the most influential participants. They hold and manage national foreign exchange reserves, intervene in currency markets to manage exchange rate volatility, and communicate monetary policy that profoundly affects currency values. The US Federal Reserve, European Central Bank, Bank of Japan, and Bank of England are among the most closely watched institutions in forex markets.

Commercial banks are the primary liquidity providers in the interbank market — the wholesale forex market where the largest trades occur. When retail and institutional clients trade through brokers, those brokers typically access pricing from the interbank market or from liquidity providers connected to it.

Multinational corporations exchange currencies as part of their normal business operations — converting export revenues, paying overseas suppliers, and managing foreign currency exposure. Their flows are large but primarily transactional rather than speculative.

Investment funds, hedge funds, and institutional investors actively trade currencies as part of portfolio management strategies, including both hedging existing foreign currency exposure in other asset classes and making directional currency trades as a source of return.

Retail traders — individuals trading through online brokers — represent a growing but still relatively small share of total forex volume. Retail traders access the market through platforms provided by brokers who aggregate liquidity from institutional sources.

Currency pairs are conventionally divided into three categories based on the currencies involved and their trading volume.

Major pairs include the US dollar as one of the two currencies and represent the most heavily traded pairs globally. They tend to have the tightest spreads and the deepest liquidity. Common majors: EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD, USD/CAD, NZD/USD.

Minor pairs (also called cross pairs) do not include the US dollar. They tend to have slightly wider spreads than majors but remain liquid markets. Common minors: EUR/GBP, EUR/JPY, GBP/JPY, AUD/JPY, EUR/AUD.

Exotic pairs combine one major currency with the currency of a smaller or emerging economy. Spreads are typically wider, liquidity lower, and volatility often higher. Examples: USD/ZAR, USD/TRY, EUR/TRY, USD/MXN.

Currency prices reflect the collective judgement of market participants about the relative value of two currencies. That judgement is influenced by a range of factors:

Interest rate differentials: Higher interest rates in one country tend to attract capital flows, increasing demand for that currency. Central bank policy decisions are among the most powerful drivers of currency moves.

Inflation: Higher inflation erodes a currency's purchasing power over time. Currencies of economies with lower inflation tend to appreciate against those with higher inflation over long periods.

Economic growth: Strong economic data — GDP growth, employment, manufacturing activity — tends to support a currency by attracting investment and supporting the case for higher interest rates.

Political stability and risk: Political uncertainty, elections, fiscal policy changes, and geopolitical events can all affect investor confidence and currency flows.

Market sentiment: In periods of global risk aversion, investors tend to buy safe-haven currencies (USD, JPY, CHF) and sell currencies of smaller, more vulnerable economies.

A pip (percentage in point) is the standard unit of measurement for price movement in forex. For most currency pairs, a pip is the fourth decimal place — a move from 1.0850 to 1.0851 is a one-pip move. For pairs involving the Japanese yen (where prices are quoted to two decimal places), a pip is the second decimal place.

Many brokers quote to a fifth decimal place — this fractional pip (sometimes called a pipette) allows for more precise pricing.

Forex is typically traded in standardised units called lots. A standard lot is 100,000 units of the base currency. A mini lot is 10,000 units. A micro lot is 1,000 units.

The lot size, combined with the pip value and any leverage applied, determines the monetary value of each pip movement in a position.

Retail traders access the forex market through brokers, who provide the trading platform, execution, and access to liquidity. Brokers make money primarily through the spread — the difference between the price at which they offer to sell a currency (the ask) and the price at which they will buy it (the bid). Some brokers also charge a commission per trade, particularly those offering tighter spreads on an ECN or STP model.