Foreign Exchange (Forex) Currency Trading Basics

March 28, 2024 Beginner
The foreign exchange (forex) market sees more than $6 trillion change hands per day. Learn the basics of currency trading.

The foreign exchange (forex) market has a daily trading volume of more than $6 trillion and is available nearly 24 hours a day, six days a week.

Forex rates are what it costs to exchange one country's currency for another country's currency. Additionally, the forex market keeps the global system of imports, exports, and payments in balance—from home goods to portfolio investments.

Understanding currency quotes

Before starting, it's important to understand that forex trading is subject to unique risks and isn't suitable for everyone. It takes time to understand how the product is traded and quoted. Currency trading on the forex market involves trading two currencies against each other, otherwise known as a pair. The quote for a forex currency pair references what it costs to convert one currency to the other.

For example, say the U.S. dollar (USD) and Canadian dollar (CAD) (USD/CAD) pair is trading at 1.34. In this scenario, $1 USD is equal to 1.34 CAD. The easiest way to understand the quote of any currency pair is to read the pair from left to right. For example, if the euro and USD (EUR/USD) pair is trading at 1.09, that means 1 euro is equal to $1.09 USD.

Currency fluctuations

Like other asset classes, currencies fluctuate for reasons like interest rates, inflation, economic growth, and future expectations. However, fluctuations in a currency are volatile as they are also relative to the same dynamics in the other half of the currency pair.

One example is from June 2016 when Britain voted to leave the European Union. The British pound (GBP) dropped from about $1.50 relative to the USD to below $1.30 within a week. The Brexit vote lowered growth and interest rate expectations among many investors. Meanwhile, the United States had begun hiking its interest rates a few months earlier. So, relatively speaking, market participants saw the dollar and dollar-based investments as having a higher return profile than those based in pounds, and the exchange rate adjusted accordingly.

Exchange rates react to economic data, meetings, and speeches by central bankers, as well as anything that might affect relative expectations of growth, interest rates, and inflation among nations and their currencies.

Price fluctuation with Brexit vote

This daily chart shows the price fluctuation between the British pound and the U.S. dollar (GBP/USD) before and after Brexit.

Source: thinkorswim® platform

For illustrative purposes only.

Currency platforms

The bulk of forex rate trading takes place in what's called the "interbank market," which is an over-the-counter (OTC) market that is not traded on an exchange. The interbank market consists of banks, dealers, and intermediary brokers.

Retail participants, in general, don't have direct access to the interbank market, but the price information is used by retail platforms offering forex trading. These platforms are retail forex brokers and are generally compensated through the bid/ask spread.

The major currencies, such as the dollar, euro, pound, and yen, usually have tight spreads, but the spreads can fluctuate during the day. Some of the more obscure pairs (called "exotics") may have wider spreads than the major pairs. Additionally, forex trading involves leverage, which means traders can establish a position in a large investment with a relatively small amount of money, which could potentially lead to magnified profits. However, leverage can compound losses as well.

There's also a futures market for currency trading. It's made up of exchange-traded, standardized contracts for future delivery of several major currencies versus the USD.

Futures contracts can be similar to forex trading because they allow traders to establish a position in a large investment with a relatively small amount of money. However, one difference in trading forex is the ability to control the size of the position you invest in. Forex can be traded in 10,000, or 100,000 lot increments, while the futures market uses a standardized contract with a defined size that may not offer the same flexibility as forex.

The foreign exchange market can potentially offer traders international exposure and long-term or short-term opportunities in cross-border interest rate differentials; however, it's important for traders to do their homework to understand the pros and cons before considering trading forex.

Futures, and Futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure Statement for Futures and Options prior to trading futures products.

Forex trading involves leverage, carries a substantial level of risk and is not suitable for all investors. Please read the NFA Booklet Trading Forex: What Investors Need to Know prior to trading forex products.

Futures and forex accounts are not protected by the Securities Investor Protection Corporation (SIPC). Forex accounts do not receive a preference in any bankruptcy proceeding pursuant to Part 190 of the CFTC's regulations.

Additional CFTC and NFA futures and forex public disclosures for Charles Schwab Futures and Forex LLC can be found here.

Futures, futures options, and forex trading services provided by Charles Schwab Futures and Forex LLC. Trading privileges subject to review and approval. Not all clients will qualify. Forex accounts are not available to residents of Ohio or Arizona.

Charles Schwab Futures and Forex LLC is a CFTC-registered Futures Commission Merchant and NFA Forex Dealer Member.

Charles Schwab Futures and Forex LLC (NFA Member) and Charles Schwab & Co., Inc. (Member FINRA/SIPC) are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation.

Charles Schwab Futures and Forex is the counterparty to all forex customer trades, and exclusively uses straight-through processing such that it automatically (without human intervention and without exception) enters into the identical but opposite transaction with another liquidity provider (creating an offsetting position in its own name).

The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.