What is forex trading?

The foreign exchange market is the largest financial market in the world, in terms of trading volume and liquidity. Known by several other names, including forex, FX or the currency market, every day over $5 trillion worth of currencies are traded across the world, dwarfing the stock market. This is done through a global network of banks, businesses and individual investors. What type of market is forex? Well, it is considered an over-the-counter (OTC) or interbank market, due to the fact the entire forex market is run electronically, continuously over a 24-hour period. Currencies are traded in major financial centres across the world, including London, New York, Tokyo and Hong Kong.

Essentially, forex is the buying and selling of currencies – to buy one currency, you have to sell another currency. All exchange rates are quoted as a pair. The first currency in the pair is known as the “base currency”, the second is called either the “quote” or “counter currency”. Simply put, the price you see represents how much of the “quote currency” you need to buy 1 unit of the “base currency”.

Let’s take some quick examples:

Why trade forex?

There are many benefits and advantages of trading forex. Besides being the most traded financial market in the world, unlike the stock market, the forex market is open 24 hours a day, 5 days a week, from Monday through to Friday. This provides a great opportunity for traders to trade at any time of the day or night.

For traders, in general the best trading opportunities are those related to the major currencies, because they are traded more frequently, and are therefore more liquid. For many traders the best time to trade is when the market is most active.

Major trading sessions

The forex market consists of three main trading sessions: Tokyo, London and New York. While Sydney is also often considered a main trading session, most market activity takes place when one of the other three markets are open (Tokyo, London and New York). When the trading day in Tokyo ends, London takes over the market and hands it to the US before it closes. This means that you can trade around the clock during the week, giving you the ultimate trading flexibility.

The busiest times of the trading day are when trading sessions overlap (as one closes, another opens). This is simply because there is more trading volume when two markets are open at the same time. This is when volatility usually tends to increase too. The overlap of the London and New York trading sessions is often seen as one of the most favourable trading times. This is because during these times both US and European traders are trading at their desks and moving markets, particularly between 2:30pm and 4:30pm when both US and European equity markets are open.

What affects forex prices?

The value of a currency can be affected by a number of factors, including political and economic instability, monetary policy, currency intervention or natural disasters. Exchange rates can be influenced by a number of important macroeconomic factors, such as a country’s economic growth and inflation. In general terms, the stronger the health of an economy, the stronger the country’s currency is likely to be. The common goal of forex traders is to profit from these changes in the value of one currency against another, by speculating on which direction you think forex prices in a particular currency pair is likely to go in the future. A trader would sell a currency pair if they believed the base currency will weaken in value against the quote currency. On the flip side, if they believed the base currency will strengthen in value against the quote currency, they would buy the currency pair.

Let’s look at the EURUSD as an example. In this case EUR is the base currency and USD is the quote currency. If a trader believed that the US economy will continue to strengthen and the currency is about to rise in value, they would execute a sell EURUSD order. This means you have bought US dollars in the expectation that the currency will rise against the euro.

World’s major currencies

Did you know, in the forex market over 85% of forex trading involves the US dollar? As a result the largest global currency reserve is the US dollar. Below is a list of the world’s most traded currencies.

Read our next article, to learn more about the different types of currency pairs to trade, currency pair nicknames and currency symbols.