How does forex trading work?

Currencies are traded in pairs.

Examples include:

• EUR/USD

• GBP/USD

• USD/JPY

• AUD/USD

• EUR/GBP

When trading a currency pair, you are considering the value of one currency relative to another.

Base and quote currencies

Consider:

EUR/USD = 1.1500

EUR is the base currency.

USD is the quote currency.

A price of 1.1500 means that one euro is valued at 1.15 US dollars.

If EUR/USD rises, the euro has strengthened relative to the dollar.

If EUR/USD falls, the euro has weakened relative to the dollar.

What does going long mean?

If a trader expects EUR/USD to rise, they may choose to go long.

This means taking a position intended to benefit from an increase in the pair.

What does going short mean?

If the trader expects EUR/USD to fall, they may choose to go short.

This means taking a position intended to benefit from a decline.

In both cases, if the market moves in the opposite direction, the trader can incur a loss.

What is a pip?

Currency movements are commonly measured in pips.

For many major currency pairs, one pip corresponds to a movement in the fourth decimal place.

For example:

EUR/USD moves from:

1.1500

to:

1.1501

The movement is one pip.

For many Japanese-yen pairs, a pip is typically measured at the second decimal place.

What is a lot?

Forex position sizes are traditionally expressed in lots.

Common conventions are:

• Standard lot — 100,000 currency units

• Mini lot — 10,000 currency units

• Micro lot — 1,000 currency units

The actual position sizes available depend on the trading product and platform.

What are major, minor and exotic currency pairs?

Currency pairs are often grouped into categories.

Major pairs

These are heavily traded pairs involving the US dollar and another major currency.

Examples include:

• EUR/USD

• GBP/USD

• USD/JPY

• USD/CHF

• AUD/USD

• USD/CAD

Cross or minor pairs

These typically involve major currencies without the US dollar.

Examples include:

• EUR/GBP

• EUR/JPY

• GBP/JPY

Exotic pairs

These generally combine a major currency with one from a smaller or emerging economy.

Exotic pairs may have different liquidity, volatility and trading-cost characteristics compared with major pairs.

What moves forex prices?

Currency prices can respond to many factors, including:

• Central-bank interest rates

• Inflation

• Economic growth

• Employment data

• Political developments

• Government policy

• International trade

• Market expectations

• Risk sentiment

Forex traders therefore pay close attention to economic announcements and central-bank decisions.

Lesson summary

• Forex currencies are traded in pairs.

• The first currency is the base currency and the second is the quote currency.

• Traders can take views on rising or falling currency pairs.

• Forex movements are commonly measured in pips.

• Position size is commonly expressed in lots.

• Interest rates and economic conditions can strongly influence currency prices.