The foreign exchange (forex) market is a dynamic, global marketplace that is open virtually around the clock and sees more than $6 trillion change hands every day across the world's central banks.
Investors, traders, and institutions use the forex market to hedge and speculate by exchanging one nation's currency for another—trading currencies in pairs to take advantage of price shifts. Forex trading is not conducted on a central exchange, which means there is no physical location where all currencies trade. Instead, forex trades in a decentralized market that functions through a global network of financial institutions.
Foreign exchange rates are frequently fluctuating because forex is open nearly 24 hours per day and responsive to shifting supply and demand factors. Rates will also move based on numerous factors like global interest and inflation rates, macroeconomic and geopolitical conditions, and inflows and outflows of foreign capital.
Here are some other factors every trader should understand before attempting to trade forex:
- Leverage: Forex trading involves leverage, meaning traders can take a position in a larger investment with a relatively small amount of initial capital. While this is enticing, leverage can magnify losses just as well as profits. A small amount of market movement can have a large effect—positive or negative—on an account's profit and loss (P&L).
- Margin: Leverage on a forex contract happens by trading on margin. A margin requirement, which acts like a good-faith cash deposit, is a fraction of the contract's notional value. In forex trading, margin requirements vary as a percentage of the notional value.1 For a 3% margin trade, for example, a trader would initially commit $3,000 for exposure to $100,000 in the forex market.
- (Very) extended trading hours: The forex market trades almost 24 hours per day, 6 days per week (Sunday evening to Friday afternoon). Therefore, traders need to be responsive daily to market conditions and economic events.
- Liquidity: Forex is a very active market with an extraordinary amount of trading volume, especially in the major currency pairs. Trading more exotic pairs, however, may present additional liquidity concerns.
How trading forex currency pairs works
The forex market involves trading two currencies against each other as a pair, effectively buying one currency and selling another at the same time. They're identified based on the symbol for the currency, such as EUR/USD (EUR for the euro and USD for the dollar). The EUR/USD pair is one of the most widely traded currency pairs. A forex trader buying the EUR/USD pair would be long the euro (EUR) and short the U.S. dollar (USD), while a trader who sells EUR/USD would be short the euro and long the dollar. Other actively traded pairs include USD/JPY, GBP/USD, USD/CAD, AUD/USD, and NZD/USD.
Major currency pairs typically consist of any two of the following currencies:
- USD: U.S. dollar
- JPY: Japanese yen
- EUR: Euro
- AUD: Australian dollar
- NZD: New Zealand dollar
- CAD: Canadian dollar
- GBP: British pound
- CHF: Swiss franc
Any other currency pairs are generally considered "exotic."
Forex currency pairs trade in increments of 10,000 units (or "mini lots") or 100,000 units (standard lots), and Schwab does not charge commissions for forex trading online. The cost of the trade is reflected in the bid/ask spread, or the difference between the buying price of one currency and the selling price of the other.
Currency pair pricing
Forex trading is measured by what are called pips, or "percentage in points." For most currencies, a pip is equal to 1/100 of a cent, or 0.0001. One exception is JPY pairs, where the pip is equal to 0.01.
For example, if the quote for the EUR/USD trade is a 1.4168 bid to a 1.4170 ask (and one pip is 0.0001), the difference in price between the bid and ask is two pips. Like traditional stock traders, forex traders buy at the ask and sell at the bid. A trader losing two pips on this trade would then calculate this by the number of units traded to determine the total amount paid. In this example, someone trading 10,000 units of a two-pip spread would enter the trade with a $2 loss.
Charles Schwab Futures and Forex does also offer trading in fractional pips, called ticks. Ten ticks equal one pip, which represents a 0.00001 move for most pairs or a 0.001 move for pairs with JPY.
Evaluating forex trading risks
Because of factors like leverage and overnight trading—which makes it impossible to constantly monitor trades—a trader should carefully consider and assess their risk tolerance before considering forex. One way to assess risk is through technical analysis, and many of the same techniques and indicators used to trade equities can also be applied to forex charts. Even simple trendlines can potentially be useful when looking for the next major trend in a currency pair, although past performance is not a guarantee of future results.
While technical analysis2 can provide insight, it shouldn't be the only tool used to evaluate trades because trends can change at any time as prices fluctuate. Traders should consider using various analytical tools to make decisions.
Source: thinkorswim® platform
For illustrative purposes only. Past performance does not guarantee future results.
Trading currencies can also provide portfolio diversification. It's another asset class and another opportunity to initiate positions to build a portfolio. For example, an investor's stock portfolio might not be doing well, and some of the losses might be offset by positive results from a profitable currency position. However, forex trading also has its own risks, and diversification does not guarantee against investment loss.
Assessing potential forex trading opportunities
The forex market offers both short- and long-term potential trading opportunities, with holding periods ostensibly ranging from a few minutes to several years. An investor focused on fundamental factors like interest rates and economic data might trade on information from news releases in search of short-term profits or even intraday price movements. Economic news releases tend to cause very short bursts of activity in the financial markets, including volatile moves in currency pairs.
Those with longer-term, buy-and-hold objectives might use fundamental analysis to analyze opportunities by monitoring monetary policy, geopolitical stability, trade balances, and more. Longer-term traders may also want to focus on currencies from stable political and economic environments versus, for example, emerging economies.
To start trading forex with Charles Schwab Futures and Forex LLC, traders need to open a standard brokerage account. The brokerage account can either be an individual, joint, corporate, LLC, trust, partnership, or sole proprietorship and needs to be approved for margin privileges. Once the brokerage account is opened and enabled for margin privileges, traders can then apply for forex access.
Once approved, traders can use the thinkorswim® platform to monitor the forex market, plan strategy, and implement their forex trades.
1Margin requirements at Schwab are typically between 3% and 5% of the notional value, although certain pairs can be as low as 2% or more than 5%.
2 Examines historical trading data, such as price and volume data, to identify previous chart patterns with the hope of anticipating stock price movements. Some technical analysis tools include moving averages, oscillators, and trendlines.
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The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment products and investment strategies mentioned are not suitable for everyone. Each investor needs to review each transaction for their own particular situation.
Past performance is no guarantee of future results.
Investing involves risk, including loss of principal, and for some products, loss of more than your initial investment.
Currency trading is speculative, volatile and not suitable for all investors.
Forex trading involves leverage, carries a substantial level of risk, and is not suitable for all investors. Please read the Risk Disclosure for Forex.
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.
Read additional CFTC and NFA futures and forex public disclosures for Charles Schwab Futures and Forex LLC.
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 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).
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 SIPC) are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation.
Schwab does not recommend the use of technical analysis as a sole means of investment research.