Forex Trading: Comprehensive Guide for Beginners and Experts

If you've already begun your investing journey, the stock market is a familiar place. But if you're looking to expand into other asset classes to try to profit — albeit while potentially adding risk — one area to consider is foreign exchange, or forex.

Forex involves trading one currency for another. For example, a person could exchange the U.S. dollar for the Japanese yen — or complete a forex derivatives trade that reflects the underlying currencies — in the hopes that the yen would strengthen against the dollar. 

Forex offers deep liquidity and 24-hour-per-day trading on weekdays, so investors have ample opportunities to get involved. But it's a more nuanced, sophisticated area of investing, so you should tread carefully.  

What is forex trading?

Forex trading involves exchanging one currency for another in order to try to profit from currency fluctuations. So rather than exchanging money at an airport kiosk, forex trading looks a little bit more like stock trading. 

However, rather than trading forex on formal exchanges like stock exchanges, the forex market is a global electronic network of banks, brokers, hedge funds, and other traders. 

Central banks are also involved in the forex market, where they're responsible for maintaining the value of their country's currency. This value is represented as the exchange rate by which it will trade on the open market. 

Market participants can trade in the spot market and also buy and sell derivatives. As a result, they can trade futures, forwards, and swaps.

The world's most-traded currency, by far, is the U.S. dollar; it experiences more than $5 trillion worth of trading volume per day, according to figures from the Bank for International Settlements (BIS). The data from BIS also reveals the euro as a not-so-close second, with more than $2.1 trillion in daily trading volume, and the Japanese yen and pound sterling are the third- and fourth-largest currencies by average daily trading volume, at $1.1 trillion and $844 billion, respectively. 

How forex trading works

Forex trading involves trading currency pairs in an effort to hedge or speculate, such as buying a JPY/USD pair to try to capitalize on changes to the Japanese yen vs. U.S. dollar exchange rate.

Essentially, you're simultaneously selling one currency and buying another, but you don't need to first own one of the currencies or take physical possession of the other. In many cases, forex trades are quoted as a price that reflects the exchange rate of two currencies, and the gains or losses depend on that price changing. Brokers often provide access to underlying currency prices via derivatives known as contracts for difference (CFDs). 

While the mechanics of CFDs can be a bit complicated, the average investor often just focuses on choosing a trustworthy forex trading platform that can handle the derivatives aspect, while the investor hopes the price of the currency pair moves up or down, depending on which side of the trade they're on.

For retail investors, the process of forex trading typically involves opening a brokerage account, funding it, and then trading. 

Hedge funds also often use brokers. "[They] generally use institutional brokers, but they often also use the same brokers as retail investors — although they will almost always negotiate volume discounts/better terms," says Tim Enneking, managing director of hedge fund manager Digital Capital Management. 

Sometimes, however, institutional investors trade directly with each other, such as in the interbank market, which is a subset of the OTC market that does not require an intermediary like a broker. The interbank market involves institutions like large banks that exchange currencies with each other and have the ability to set exchange rates because of the magnitude of their trades.  

Investors trade currencies in lots, which are simply the number of units of those currencies. There are standard, mini, micro, and nano lots, which consist of 100,000, 10,000, 1,000, and 100 currency units, respectively. 

Traders frequently aim to capitalize on small fluctuations in exchange rates, which are measured in pips, which represent one one-hundredth of 1 percentage point. 

Currency pairs

Investors trade forex in pairs, which list the base currency first that's being bought or sold, and the quote currency second that the currency is being exchanged for. For example, if someone trades the JPY/USD, the Japanese yen is the base currency, and the U.S. dollar is the quote currency.

Investors who are interested in forex have the ability to trade several different currency pairs: major pairs, minor pairs, exotic pairs, and regional pairs. 

• The major pairs involve the U.S. dollar, such as the USD/JPY, GBP/USD (British pound sterling), USD/CHF (Swiss franc), and EUR/USD (euro). In all, seven major pairs, all involving USD, account for 75% of forex trades, according to CMC Markets.
• The minor pairs consist of major currencies traded against each other, but not the US dollar, such as GBP/JPY, EUR/GBP, and EUR/CHF, explains tastyfx. 
• Exotic pairs involve a major currency combined with a minor currency, such as EUR/CZK (Czech koruna), USD/PLN (Polish złoty), and GBP/MXN (Mexican peso). 
• Regional pairs involve currency pairs within the same region. For example, AUD/NZD (Australian Dollar/New Zealand Dollar) is an Australasia regional pair.

Market hours

Because forex trading happens on the over-the-counter (OTC) market rather than a formal exchange, there are no set hours the way that a stock exchange like the New York Stock Exchange has defined trading hours. Still, forex markets generally depend on the business hours of banks, hedge funds, brokers, and others typically involved in forex transactions. 

Yet because of the global nature of these transactions, investors can typically trade 24 hours a day starting at 5 p.m. ET on Sunday through 5 p.m. ET on Friday. These hours reflect how key forex hubs like Tokyo trade during what is Sunday night in the U.S., while the 5 p.m. ET closure on Friday when the New York market closes.

Generally, forex markets are closed on weekends, but it's possible some investors still trade during off-hours. With the OTC market, transactions can take place whenever two parties are willing to trade.

Leverage and margin

In addition to offering deep liquidity and often 24-hour-a-day access, many forex brokers provide easy access to leverage. With leverage, you essentially borrow money to invest by putting down a smaller amount, known as margin. For example, you might deposit $1,000 as margin, and then if the broker provides a 10% margin rate, that means you can invest $10,000 based on the $1,000 in margin, giving you leverage.

"You can easily trade using leverage which means that you need relatively little capital to be able to trade forex," says Julius de Kempenaer, senior technical analyst at StockCharts.com.

The downside is that you're fully liable for leveraged losses, and it's not as if the $10,000 is yours to keep. If that $10,000 falls to $5,000, you owe $5,000.

The upside is that if the $10,000 jumps to $15,000, you've gained $5,000. In other words, leverage gives you the opportunity for larger gains — as well as larger losses — than if you just normally invested the margin amount.

Leverage is common in forex because it can be hard otherwise to have enough funds to make significant profit. As Enneking notes, the forex market has low volatility in terms of big price swings, so "without leverage, it's a difficult market to make real money in."

Yet that's part of what makes forex so risky. In learning forex trading strategies for beginners, many retail investors get drawn in by the easy access to leverage without understanding all the nuances of the market, and leverage could amplify their losses.

Forex trading strategies

For those who decide to engage in forex trading, there are many different strategies to choose from. Some involve a lot of speculation, while others involve long-term risk management. 

Broadly, forex trading strategies, like other forms of investing, generally fall into one of two camps: technical analysis or fundamental analysis.

Time-based trading

In addition to fundamental analysis vs. technical analysis, forex trading can also be based on time-related trades. These might still be based on fundamental or technical analysis, or they might be more speculative gambles in the hopes of making a quick profit, without much analysis. Of course, that generally means taking on more risk.

Some time-based trading approaches include: 

Day trading

Day trading involves buying and selling the same position within the same day. For example, if you day trade the EUR/USD pair, you might first buy the position at a price of 1.10 and sell it later that day for 1.101 for a slight gain. Remember, forex prices tend to not have a ton of volatility, in the sense that price changes are usually minimal. That's why some traders take on the risk of leverage to try to amplify gains if they think they can take advantage of small intraday price changes.

Scalping

Scalping refers to making trades that profit from small changes in the value of forex pairs, often within minutes of the initial trade. In many cases, it's a short-term version of day trading. Individual investors may be taking on risk by engaging in such short-term bets, but they generally have more leeway to do so than compared to most stock and bond trades.

"It is no problem to day trade or scalp as the forex market is a lot less regulated than the stock/bond market," says de Kempenaer.

Swing trading

Another approach that some forex traders take is swing trading, which is similar to day trading but typically takes place over a few days or weeks, rather than just within a single day. For example, a trader might notice that there's been recent momentum in the euro's strength vs. the U.S. dollar, so they might buy the EU/USD pair, in the hopes that in a week or so they can sell for a gain, before the momentum fizzles.

Position trading

Position trading generally means long-term investing, rather than short-term speculation like with day trading, scalping, or swing trading. Perhaps you want to hedge against the risk of some currencies falling, such as if you own real estate in another country and want some long-term protection. So, you could engage in position trading, where if the value of that currency falls, thereby weakening the value of your real estate in relation to your home currency, you might at least gain from the position trade.

Technical analysis in forex trading

One approach to forex trading is to use technical analysis, which means basing trading decisions on price activity, rather than the underlying principles that might support a given price. 

Suppose investors are eager to buy U.S. dollars, causing the price of USD to gain vs. JPY. Even if there's no apparent underlying economic reason why the U.S. economy should be viewed more favorably than the Japanese economy, a technical analysis might identify that when the USD gains, say, 2% in one week, it tends to increase another 2% the following week based on momentum, with investors piling onto the trade for fear of missing out. 

Or maybe if the USD reached its highest value over the past year and trading activity stalls around that price point, technical analysis might point to that being a resistance level, meaning that the USD price might have trouble rising above that mark.

Keep in mind that these are hypotheticals, and different investors have their own beliefs when it comes to technical analysis. 

Fundamental analysis in forex trading

As opposed to technical analysis that bases predictions on past price movements, fundamental analysis looks at the underlying economic/financial reasons why an asset's price may change. 

For example, fundamental analysis might conclude that the U.S. economy will likely grow faster than the EU's, based on expectations around consumer spending. If that happens, then the USD might gain strength against the euro, so a forex investor using fundamental analysis might try to get on the right side of that trade.

Another fundamental analysis factor could be interest rates. If U.S. interest rates are expected to fall faster than the EU's, that could cause investors to favor buying bonds in the EU, thereby driving up demand for the euro and weakening demand for the dollar. So, this fundamental analysis might indicate that an investor should buy the EU/USD pair.

Again, these are just hypotheticals, but the point is that fundamental analysis bases trading on underlying factors that drive prices, besides trading activity.

Choosing a forex broker

In addition to figuring out the right forex trading strategy, it's important to choose a solid forex broker. That's because brokers can have different pricing, such as the spread they charge between buy and sell orders, which can cut into potential gains. Also, many retail forex brokers enable individuals to open brokerage accounts, meaning that you're storing funds and assets with that broker, so you want to find one with strong reviews and practices that you deem trustworthy.

Regulation and security

While forex trading is generally less strictly regulated than stock trading, you still want to choose a broker that adheres to relevant regulations. For example, in the U.S., you might look for a broker that's regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).

You also want to review a broker's security practices to ensure that your money is safe, such as checking whether the broker segregates client funds from their own and holds them at regulated banks.

Trading experience

The forex trading experience can vary among the best forex trading platforms, so you want to find one with a user experience that feels right to you. This can be subjective, so you might want to look for a broker that offers demo accounts where you can get a feel of what trading on that platform looks like.

Account types

Different brokers may have different account types, such as with some geared more toward beginner retail investors, and others toward more professional traders. Take a look at what different brokers offer such as in terms of account fees, assets that can be traded in different accounts, and eligibility requirements.

Risk management in forex trading

While forex trading can provide an enticing alternative to traditional stock and bond investing, it's important to not get too caught up in the potential for gains. You need to be mindful of the downsides too, especially if using leverage, which can amplify losses. 

The right risk management strategy depends on your situation, but some common approaches and tactics to consider include:

Stop-loss orders

A stop-loss order triggers a buy or sell order once a designated price is reached. For example, if the EUR/USD pair you own is trading at 1.09268, maybe you'd set a stop-loss order so that if the price falls to 1.09260, your broker would then sell your asset. 

Keep in mind that the actual price might be higher or lower than the stop-loss number, because prices can change quickly, and by the time your order goes through, the price may have moved. Still, a stop-loss order can limit risk, as you can exit a position if it starts falling, without having to constantly check prices and manually issue a sell order at the price point you're looking for.

Similarly, limit orders specify the highest or lowest price you'd be willing to buy or sell at, though the order doesn't provide as much downside protection the way that stop-loss orders do. A stop-limit order also puts some parameters around the price you're willing to buy or sell an asset at by specifying when the order should be triggered and the price you'd be willing to execute at, which can help you manage risk, although the order might be less likely to execute than a stop-loss if prices quickly move outside the limit.

Position sizing

The size of your various forex positions also plays an important role in risk management. Just like with stocks, it can be risky to have all your money in one place. So, you might determine a maximum position size that aligns with your risk tolerance, such as making sure no position accounts for more than 1% of your portfolio.

Plus, you might decide to limit your overall forex positions to a slice of your overall investing portfolio, that way you're not overexposed to forex.

Risk-reward ratio

While determining risk-reward ratios isn't always easy, it might help to think in terms of what you're willing to risk in order to gain a certain amount. For example, if you're willing to risk your entire investment, you might look for an exotic pair that has more volatility, and thus more potential for reward. 

However, if you're only willing to take on a small risk-reward ratio, you might use tactics like stop-loss or stop-limit orders, such as to try to limit your losses to 10%, while cashing out if you gain 10%.

Some investors set specific risk-reward ratios, such as 1:2, meaning they'd be willing to risk a certain amount to try to gain twice as much. For example, if you risk $1,000, you might set a limit for yourself that you'll exit the position if it gains $2,000. Using stop-loss or stop-limit orders can help you stay within your risk-reward ratio.

Common mistakes to avoid in forex trading

Related to risk management, it's important to watch out for common mistakes in forex trading that can lead to more losses than you're comfortable with. Some of the top issues include:

Overleveraging

Because leverage is often easy to obtain in forex, it's easy to become overleveraged, resulting in being on the hook for more than you can afford to lose. Maybe you only have $1,000 in cash and put that up as margin to then access $20,000. But that could mean you're overleveraged, because if you end up losing 10%, you'd be down $2,000, which is $1,000 more than you had in cash.

Overtrading

Overtrading can be another mistake, as you might get too caught up in trying to make a quick profit and end up hurting your performance in the long run. 

What constitutes overtrading can be subjective; some day traders and scalpers might not be overtrading if they can successfully profit from small moves. But if you find yourself panic selling at every dip or buying with regret after missing out on an upward move, that could mean you're overtrading.

Making uninformed trades

Lastly, you probably don't want to treat forex like gambling, yet if you're not making informed trades, then you're essentially rolling the dice. Many people look for forex trading tips for success but never actually learn technical or fundamental analysis, so they're just trading on gut feelings, which can be risky.

Forex trading Frequently Asked Questions (FAQs)

Charles Lloyd Bovaird II

Charles Lloyd Bovaird II is a personal finance expert who has been published over 1,000 times across platforms including Business Insider, CoinDesk, Forbes, Investopedia, and The Washington Post.ExperienceWhile working at Brafton, Inc. as a News and Content Writer and then a Senior Writer, Charles developed financial education materials to train internal staff and led courses on financial market coverage for writers and editors. He also wrote educational articles on subjects including investing, real estate, and financial planning. He’s spoken at industry events across the world and delivered speeches on financial literacy for Mensa and Boston Rotaract. He covered cryptocurrency for the blockchain publication CoinDesk and currently writes a column for Forbes focused on global asset markets and digital currencies. He’s also an independent consultant for Moody’s Analytics and has worked for other financial institutions including Citizens Commercial Banking and State Street.Charles specializes in distilling complex financial topics in an easy, understandable way so readers can take action and make the most of their money.ExpertiseCharles’ areas of personal finance expertise include:

• Investing
• Stocks
• Bonds
• Currencies
• Crypto
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• Financial planning 
• Asset markets

EducationCharles holds a Bachelor's Degree in Economics and Political Science, Summa Cum Laude, from the University of Massachusetts Boston. 

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Jake Safane

Jake Safane is a freelance writer specializing in finance and sustainability. He runs a corporate sustainability blog, Carbon Neutral Copy, and his work has appeared in publications such as The Economist, CBS MoneyWatch, and the Los Angeles Times.ExperienceJake has been working in financial journalism since 2011, covering areas such as banking and investing for both businesses and individuals. His career has included a mix of in-house reporting jobs at B2B finance publications such as Global Custodian and FundFire, a role in sponsored research at The Economist, and freelance engagements with online publications, financial advisors, and fintech companies.His interest in personal finance dates back to joining his middle school stock trading club, where he learned about markets by doing simulated trading. A high school field trip to the New York Fed further cemented his fascination with the financial system and how seemingly academic concepts can make a big difference in the average person's life.His personal interest in the environment has also carried over into finance, such as by covering ESG and impact investing. He believes that one of the top ways to solve the climate crisis is by helping both businesses and individuals realize the long-term financial benefits that sustainability can bring.In his personal life, he also enjoys playing tennis, going to the gym, and going to the beach with his family — though often just for walks along a paved path, because vacuuming sand trekked in by a toddler and dog really cuts into writing time.ExpertiseJake’s areas of personal finance expertise include:

• Investing
• Banking
• Financial Planning
• Retirement
• Insurance

EducationJake is a graduate of Boston University, where he wrote for The Daily Free Press and had a show on the school's radio station.

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