Foreign Exchange (Forex) Trading for Beginners

Retail clients generally have two ways to trade currencies:

• Futures market. A futures contract is an agreement to buy or sell a predetermined amount of a commodity or financial instrument at a certain price on a stipulated date. These contracts are traded on exchanges, and volume is typically limited to major currencies like the U.S. dollar (USD), euro (EUR), British pound (GBP), Japanese yen (JPY), and Canadian dollar (CAD).
• Forex market. Most foreign exchange trading takes place among institutional players—banks, dealers, and large intermediaries—in what's known as the interbank market. Retail forex brokers like Charles Schwab Futures and Forex use this information to post competitive bids and offers for retail traders to sell or buy currencies in specific increments.

To trade both futures and forex, a trader needs to apply for a qualified account through their brokerage account. 

Forex trading is subject to unique risks and isn't suitable for everyone. It also takes time to understand how the product is traded and quoted. Currency trading on the forex market happens in pairs because two currencies are traded simultaneously. The quote for a forex currency pair references what it costs to convert one currency to the other.

For example, if the U.S. dollar and Canadian dollar (USD/CAD) pair is trading at 1.34, it means that $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 U.S. dollar (EUR/USD) pair is trading at 1.09, that means 1 EUR is equal to $1.09 USD. 

Like all asset classes, currencies fluctuate for reasons like interest rates, inflation, economic growth, and future expectations. However, currency fluctuations are especially volatile because they're relative to the same dynamics in the other half of the pair. Exchange rates react to economic data, government meetings, and speeches by central bankers, as well as anything that might affect relative expectations of growth, interest rates, and inflation among countries and their currencies.

One extreme example of currency volatility happened in June 2016 when the United Kingdom voted to leave the European Union. The Brexit vote lowered growth and interest rate expectations among many investors, and the British pound (GBP) dropped from about $1.50—relative to the USD—to below $1.30 within a week. Meanwhile, the United States had begun hiking its interest rates a few months earlier. So, relatively speaking, market participants considered the U.S. dollar and dollar-based investments to have a higher return profile than its GBP counterparts, and the exchange rate adjusted accordingly. 

Forex traders should also understand how interest rates could impact their profit and loss (P&L) when holding positions from one trading day to the next. In forex trading, a trader holding a currency pair is essentially long one currency and short the other. A trader may earn interest on the long currency and pay interest on the short currency when holding a position from one trading day to the next. The gap between the two interest rates amounts to what's called the "net financing rate" and could result in a cash debit or credit to your account. 

Traders new to the forex market can experiment with their strategies using the paperMoney^® feature on the thinkorswim^® platform. This simulated trading environment allows traders to practice, test strategies, and begin to explore forex dynamics without risking a dollar, euro, pound, or yen.