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.

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 circ*mstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.

I'm an experienced trader and enthusiast deeply entrenched in the world of currency trading, also known as forex or FX trading. My expertise stems from years of actively participating in the forex market, honing my skills through extensive education, hands-on practice, and continuous market analysis. Allow me to delve into the concepts outlined in the provided article to demonstrate my comprehensive understanding:

Currency Trading Overview: Currency trading involves the buying and selling of currencies in the foreign exchange market. It's renowned as the largest investment market globally, with daily trading volumes surpassing $4-5 trillion. This vast market size provides ample opportunities for traders to capitalize on price movements.
Forex Market Liquidity and Major Pairs: The forex market operates 24/7, allowing traders to engage in transactions at any time. Despite its continuous nature, trading sessions in different regions (Europe, Asia, and the United States) exhibit varying levels of activity. The market primarily revolves around a select few currency pairs, approximately 18, with the most liquidity concentrated in major pairs like EUR/USD, GBP/USD, and USD/JPY.
Currency Pair Quoting and Pip Movement: In forex trading, currencies are always traded in pairs, with prices quoted to the fourth decimal place in most cases. This smallest price increment is known as a pip, representing 1/100 of 1%. However, currency pairs involving the Japanese Yen may have pips represented by the second decimal place. Understanding pip movement is crucial for assessing profit and loss in trades.
Lot Sizes and Risk Management: Forex trading offers flexibility in choosing lot sizes, ranging from micro-lots (1,000 units) to standard lots (100,000 units). Adjusting lot sizes enables traders to manage risk effectively, particularly for beginners who often start with micro or mini lots to mitigate potential losses.
Factors Influencing Currency Prices: Currency prices fluctuate due to various factors such as economic indicators, geopolitical events, interest rates, and market sentiment. Understanding these drivers is essential for devising effective trading strategies and capitalizing on price movements.
Currency Trading Terminology: Common terms like "forex" or "FX" stand for foreign exchange, reflecting the exchange of currencies in the global market. Additionally, currency pairs are quoted in direct or indirect formats, where the base currency appears first, and the quote currency second.
History and Evolution of Currency Trading: While currency exchange has roots in ancient civilizations, modern forex trading as we know it emerged in 1973 with the shift from the gold standard to free-floating exchange rates.

In conclusion, currency trading offers vast opportunities for investors worldwide, but success requires a solid understanding of market dynamics, risk management strategies, and continuous learning. With the right education and practice, traders can navigate the complexities of the forex market and potentially achieve their investment goals.