Forex Trading: What Is A Forex, and How Does It Work?

What is Forex trading, and how does it work?

We heard the words Forex, Foreign Exchange, FX and Forex Market. But some of us do not know what is Forex trading, and how does it work? Do not worry; here, we discuss the fundamentals of Forex trading.

What is Forex trading?

Forex, also known as Foreign exchange, FX, Forex trading, and Currency trading. The simple definition of forex trading is buying and selling foreign currencies. It is a decentralized global market where all the world's currencies are traded. The Forex market is huge and most liquid in the world. The foreign exchange market's daily trading volume is more than $5 trillion.

How does Forex work?

Unlike other financial instruments such as shares, forex trading does not take place on exchange the currencies. The transactions occurred between two parties in an over-the-counter (OTC) market. There have no time limits for forex trading. Anyone can be trading currency pairs in anytime where the forex market is open. Because of different time zone, at any given time, somewhere around the world, a forex trading center is open. The world four major forex trading centers are London, New York, Sydney, and Tokyo.

What are the most currency pairs traded in the forex market?

We can divide currency pairs into three categories based on liquidity and volatility. Such as:

1.      Major Currency Pairs

There are seven major currency pairs. These are the most traded currency pairs on the forex market. These Major currency pairs are represented around 80% of the trade volume on the forex market.

These seven currency pairs have high liquidity and low volatility. These have smaller spreads than other pairs. These seven currency pairs are:

• EUR/USD: Euro/ US Dollar
• USD/JPY: US Dollar/ Japanese Yen
• GBP/USD: British Pound/ US Dollar
• USD/CHF: US Dollar/Swiss Franc
• AUD/USD: Australian Dollar/ US Dollar
• USD/CAD: US Dollar/ Canadian Dollar
• NZD/USD: New Zealand Dollar/ US Dollar

2.      Minor Currency Pairs

Minor currency pairs are pairs that do not include the USD. It is also known as Cross currency pairs. First, Crosses were converted into USD and then into the desired currency. Now also Crosses offered for direct exchange.

They are less liquid and more volatile than Major currency pairs. The most-traded minor currency pairs are:

• EUR/GBP: Euro/ British Pound
• EUR/JPY: Euro/ Japanese Yen
• GBP/JPY: British Pound/ Japanese Yen
• CHF/JPY: Swiss Franc/ Japanese Yen
• NZD/JPY: New Zealand Dollar/ Japanese Yen
• CAD/CHF: Canadian Dollar/ Swiss Franc
• AUD/JPY: Australian Dollar/ Japanese Yen 

3.      Exotics

Exotics are paired with a major currency against one from a small or emerging economy. Exotics are much riskier to trade than Major and Mino currency pairs.

Exotics are less liquid,  more volatile, and wider spreads than others. Example of Exotic pairs are:

• USD/MXN: US Dollar/ Mexican Peso
• GBP/NOK: British Pound/ Norwegian Krone
• GBP/DKK: British Pound/ Danish Krone
• CHF/NOK: Swiss Franc/ Norwegian Krone
• EUR/TRY: Euro/ Turkish Lira
• USD/TRY: US Dollar/ Turkish Lira

How to buy and sell currency?

All currency trades involve with two currencies. Because we buy and sell one currency against another currency. For example, EUR/USD is the most traded currency pair in the world. Here, the Euro is the base currency, and USD is the counter in the pair. A currency pair will quote two different prices in forex trading. One is the “Ask price”, and another one is the “Bid price”. Forex traders can buy currency at Ask (Buy) price, and traders can sell currency at Bid (Sell) price.

The difference between Ask price and Bid price is called the spread. Traders will buy forex currency when the price is low and sell when the price rises. Because of the high trading volume and liquidity, the Spreads tend to be tighter for the major currency pairs.

Example of Forex Trading

Suppose the EUR/USD Ask (buy) price is 0.82010, and the Bid (sell) price is 0.82020, then the spread is 1 pip. If the trade moves in your favor and covers the spread, you could make a profit. Otherwise,  you could make a  loss if the trade moves against you.