What Is Forex Trading And How Does It Work?

Each country has a currency they accept as a legal tender and use to pay for services. See what is Forex trading and how does it work.


Each country or regional block has a currency they accept as a legal tender and use to pay for goods and services. The most common currencies include the US Dollar, Sterling Pound, the Euro, and the Japanese yen, just to mention a few. These currencies are accepted and used to pay for goods and services internationally. Therefore, the value of currency changes in line with the value of goods and services produced in a country. When the value of a currency goes up relative to each other, it allows a trader to profit. In this article, you’ll learn what is Forex trading and how does it work.


The forex market is thus, a financial market where traders buy and sell foreign currencies. It is the largest market in the world in terms of liquidity and operates on a 24-hour basis. It opens early on Monday to late on Friday. The market attracts players like hedge funds, investment firms, banks, and retail traders.

Notice that the forex market has no central location or a common marketplace where traders meet physically to transact. Instead, it is executed electronically via a network of computers. It is, therefore, an over-the-counter market.  Currently, the market traded volume is more than $6.6 trillion. Continue reading to see how forex trading works.

Buying And Selling A Currency Pair

Buying and selling foreign currencies is akin to buying stock and securities. The only difference is that foreign exchange currencies are paired, so you trade pairs of currencies. We have pairs like EUR/USD, JPY/GBP, USD/CAD etc. So you trade forex by either buying or selling a currency. When you buy a currency and its price rises, you make a profit. Similarly, when the price of a currency starts falling, trader profits by selling the currency.

For instance, if the exchange rate for the EUR/USD is 1.2 to 1, you will part with $1200 to buy 1000 euros. But if something happens in the European Union zone, the exchange rate moves from 1.4 to 1; you can sell the 1000 euros at $1.4 each and receive $1400.  The difference between the buying price of $1200 and the selling price of $1400 constitutes your profit. In this example, you will make $1400-$1200=$200

Thus, forex trading is a speculative process meaning that you must keep your eye on the events happening across the globe to accurately determine the direction in which a currency pair will be moving. It is vital to keep your eyes on political events, economic activities, trade flow, and geopolitical happenings that are likely to affect the demand and supply of forex. The market is very volatile, and so it offers experienced traders plenty of opportunities.

What Is Forex? Trading Platforms

Since there is no physical market, you need a platform to trade. The platforms allow one to execute trades on laptops, phones, PC or tablets.

To trade the currencies on these platforms, a trader must understand the currency pair they target. The process entails buying and selling two currencies at the same time. Typically, a currency pair consists of the quote and a base currency. For instance, in EUR/USD, the euro is the base currency while the USD is the quoted currency. So when a trader places a buy on EUR/USD pair, it means they are buying the euro while selling the American dollar.

If you correctly predict the direction in which a currency pair moves, you will make a profit as long as it moves in that direction. 

Pips: What is Forex Trading

For the leading currency pairs, the fourth decimal, referred to as a pip, determines the profit you make. But the Japanese Yen has 2 decimals. Thus, a difference of several pips in any currency pair can result in a significant profit if a trader correctly predicts the direction of a currency. In addition, since there are large trading volumes, a small spread is likely to lead to significant losses.

Long and Short Positions

A long position- a trader will always hold a position when a trade is in progress. And will make a profit/ loss until he closes the position. A trader can hold long or short positions. A trader is to hold a long position when buying a currency. But when they sell the currency, the long position is out.

In our example, when a trader buys 1EUR in USD 1.2, they may hold the position hoping that the price rises so that they can sell it when the highest price is attained.

A short position- a trader holds a short position when they sell a currency expecting that the value falls to the lowest level before they can buy it again. Once they start buying the currency, a short position is said to be closed.