How Forex Works: Understanding the Basics of Currency Trading


Forex trading, also known as foreign exchange trading, is the act of buying and selling currencies with the aim of making a profit. The forex market is the largest and most liquid financial market in the world, with an average daily trading volume of around $5.3 trillion. In this article, we will discuss the basics of forex trading and how it works.

Currency Pairs

Forex trading involves the exchange of one currency for another. Currencies are always traded in pairs, such as EUR/USD, GBP/USD, and USD/JPY. The first currency in the pair is called the base currency, while the second currency is called the quote currency. The value of the base currency is always equal to 1. For example, if the EUR/USD pair is trading at 1.1350, it means that 1 euro is worth 1.1350 US dollars.


Bid and Ask Price

When trading forex, you will see two prices for each currency pair: the bid price and the ask price. The bid price is the price at which you can sell the base currency, while the ask price is the price at which you can buy the base currency. The difference between the bid and ask price is called the spread. The spread is the cost of trading and is how forex brokers make money.


Forex trading is typically done with leverage, which allows traders to control a large position with a small amount of capital. Leverage is expressed as a ratio, such as 1:100 or 1:500. This means that for every $1 of capital, a trader can control a position worth $100 or $500. While leverage can increase profits, it also increases risk. Traders can lose more than their initial investment if the market moves against them.


Margin is the amount of money that a trader must deposit with their broker in order to open a position. Margin requirements vary between brokers and can range from 1% to 10% or more. For example, if a broker requires a 1% margin, a trader must deposit $1,000 to control a position worth $100,000. Margin is used to cover any potential losses that may occur in the trade.


Pips are the smallest unit of measurement in forex trading. They represent the fourth decimal place in a currency pair. For example, if the EUR/USD pair moves from 1.1350 to 1.1355, it has moved 5 pips. Pips are used to calculate profits and losses in forex trading.

Long and Short Positions

In forex trading, a long position is when a trader buys a currency pair with the expectation that the value of the base currency will increase. A short position is when a trader sells a currency pair with the expectation that the value of the base currency will decrease. Traders can make money in both rising and falling markets.


Forex trading is a complex and risky activity that requires a solid understanding of the market and its mechanics. It is important for traders to have a trading plan and to manage their risk carefully. With the right knowledge and tools, forex trading can be a profitable venture.