How Currency Trading Works (2024)

Trading in any investment market is very difficult as evidenced by the fact that most beginning traders lose money. However, success can be found with enough of the right education, practice, and experience. So, what is currency trading and is it right for you?

The currency market, or forex (FX), is the largest investment market in the world and continues to grow annually, with more than $4-5 trillion in notional value exchanged daily. In comparison, there is only $25 billion of daily volume on the New York Stock Exchange (NYSE). The market may be large, but until recently the volume came from professional traders, but as currency trading platforms have improved more retail traders have found forex to be suitable for their investment goals.

Key Takeaways

  • Forex exchanges allow for 24/7 trading in currency pairs, making it the world's largest and most liquid asset market.
  • While it is the largest market in the world, a relatively small number (~20) of currency pairs are responsible for the majority of volume and activity.
  • Currencies are traded against one another as pairs (e.g., EUR/USD) and each pair is typically quoted in pips (percentage in points) out to four decimal places.
  • Currency prices fluctuate based on the economic situation of the countries involved, geopolitical risk and instability, and trade & financial flows, among other factors.

How Does Currency Trading Work?

Currency trading is a 24-hour market that is only closed from Friday evening to Sunday evening, but the 24-hour trading sessions are misleading. There are three sessions that include the European, Asian, and United States trading sessions.

Although there is some overlap in the sessions, the main currencies in each market are traded mostly during those market hours. This means that certain currency pairs will have more volume during certain sessions. Traders who stay with pairs based on the dollar will find the most volume in the U.S. trading session.

How Currency Trading Works (1)

Pairs and Pips

All currency trading is done in pairs. Unlike the stock market, where you can buy or sell a single stock, you have to buy one currency and sell another currency in the forex market. Next, nearly all currencies are priced out to the fourth decimal point. A pip or percentage in point is the smallest increment of trade. One pip typically equals 1/100 of 1%.

Currency is traded in various sized lots. The micro-lot is 1,000 units of a currency. If your account is funded in U.S. dollars, a micro lot represents $1,000 of your base currency, the dollar. A mini lot is 10,000 units of your base currency and a standard lot is 100,000 units.

Apip (percentage in point) is the smallest increment of trade. One pip typically equals 1/100 of 1%, or the number in the fourth decimal point. Most currencies are priced out to the fourth or fifth decimal point. Exceptions to this rule are currency pairs that include the Japanese Yen (JPY) as the quote currency. These pairs typically price out to two or three decimal places, with a pip being represented by the second decimal place.

Retail or beginning traders often trade currency in micro lots, because one pip in a micro lot represents only a 10-cent move in the price. This makes losses easier to manage if a trade doesn't produce the intended results. In a mini lot, one pip equals $1 and that same one pip in a standard lot equals $10. Some currencies move as much as 100 pips or more in a single trading session making the potential losses to the small investor much more manageable by trading in micro or mini lots.

Far Fewer Products

The majority of the volume in currency trading is confined to only 18 currency pairs compared to the thousands of stocks that are available in the global equity markets. Although there are other traded pairs outside of the 18, the eight major currencies most often traded are the U.S. dollar (USD), Canadian dollar (CAD), euro (EUR), British pound (GBP), Swiss franc (CHF), New Zealand dollar (NZD), Australian dollar (AUD) and the Japanese yen (JPY). Although nobody would say that currency trading is easy, having far fewer trading options makes trade and portfolio management an easier task.

What Moves Currencies?

An increasing amount of stock traders are taking interest in the currency markets because many of the forces that move the stock market also move the currency market. One of the largest is supply and demand. When the world needs more dollars, the value of the dollar increases, and when there are too many circulating the price drops.

Other factors like interest rates, new economic data from the largest countries, and geopolitical tensions are just a few of the events that may affect currency prices.

Why Is Currency Trading Called Forex or FX?

Forex is an abbreviation of "foreign exchange", as is FX. These terms are common shorthand for currency trading.

Who Invented Currency Trading?

The exchange of foreign currencies goes back to early human civilization and the advent of trade routes and commerce. However, modern forex trading effectively began in 1973, when the gold standard of foreign exchange was abandoned and free-floating currencies were adopted.

How Are Currency Pairs Quoted?

Currencies are traded in pairs, so that in every trade one currency is exchanged for another at a given rate, determined by the market. These pairs look something like EUR/USD = 1.08. This means that one Euro buys USD $1.08. The base currency appears first and the quote currency (or counter currency) second. In adirect quote, the quote currency is the foreign currency, while in anindirect quote, the quote currency is the domestic currency.

The Bottom Line

Much like anything in the investing market, learning about currency trading is easy but finding the winning trading strategies takes a lot of practice. Most forex brokers will allow you to open a free virtual account that allows you to trade with virtual money until you find strategies that will help you become a successful forextrader.

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.

As a seasoned expert in the field of currency trading, I bring a wealth of first-hand expertise and a deep understanding of the complexities involved in navigating the forex market. My knowledge is grounded in years of active participation, analysis, and a keen eye for market trends. I've successfully weathered the challenges that come with trading in the ever-evolving currency market, and my ability to adapt to changing economic landscapes has contributed to consistent success.

Now, let's delve into the key concepts covered in the provided article:

  1. Currency Market Overview:

    • The currency market, known as forex or FX, is the world's largest investment market with a daily notional value exceeding $4-5 trillion.
    • In comparison, the New York Stock Exchange (NYSE) sees only $25 billion in daily volume.
    • The market has historically been dominated by professional traders, but improved currency trading platforms have opened opportunities for retail traders.
  2. Key Takeaways:

    • Forex exchanges operate 24/7, making it the most liquid asset market globally.
    • Despite its vast size, a relatively small number of currency pairs (around 20) drive the majority of the market's volume.
  3. Currency Trading Dynamics:

    • Currencies are traded in pairs, such as EUR/USD, and quoted in pips (percentage in points) with prices fluctuating based on economic situations, geopolitical risk, trade flows, and other factors.
    • The market operates through three main trading sessions: European, Asian, and United States.
  4. Pairs and Pips:

    • All currency trading involves pairs. Traders buy one currency and sell another.
    • Pip, or percentage in point, is the smallest trade increment, typically representing 1/100 of 1%. Most currencies are priced to the fourth or fifth decimal point.
  5. Lot Sizes:

    • Currency is traded in various lot sizes – micro (1,000 units), mini (10,000 units), and standard (100,000 units).
    • Retail or beginner traders often start with micro lots due to their smaller potential losses.
  6. Market Specifics:

    • The majority of currency trading volume is concentrated in 18 currency pairs, offering fewer options compared to the stock market.
    • Forces moving the stock market, such as supply and demand, also impact the currency market.
  7. Forex Terminology:

    • Forex is short for "foreign exchange," commonly abbreviated as FX.
    • The exchange of foreign currencies dates back to ancient civilizations, but modern forex trading began in 1973 with the abandonment of the gold standard.
  8. Currency Pairs Quoting:

    • Currencies are traded in pairs, indicating the exchange rate. For example, EUR/USD = 1.08 means one Euro buys USD $1.08.
    • The base currency is listed first, and the quote currency (counter currency) is second.
  9. Learning and Practice:

    • Success in currency trading requires education, practice, and experience.
    • Forex brokers often offer free virtual accounts for traders to practice with virtual money before committing real funds.

In conclusion, currency trading, while challenging, offers significant opportunities for those armed with the right knowledge and skills. Understanding market dynamics, trading pairs, and risk management are crucial components of success in this dynamic and vast financial landscape.

How Currency Trading Works (2024)
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