How Does the Forex Market Work?

In the forex market, you trade one currency for another. The two currencies being traded are known as a currency pair. Here are some examples:

    USDJPY - buy Japanese yen with US dollars
    JPYUSD - buy US dollars with Japanese yen
    USDCHF - buy Swiss francs with US dollars
    CHFUSD - buy US dollars with Swiss francs

The main currencies
The main currency used in forex is the US dollar; 40% of transactions involve the dollar. Other major currencies include the following:

    Japanese yen
    Swiss francs
    British pounds
    Euros
    Canadian dollars
    Australian dollars
    New Zealand dollars

Although the US dollar still predominates, “cross rate” trading is increasing in Europe. This is where currencies are traded without using the dollar as an intermediary; for example, you can trade euros for British pounds or yen directly.
Types of transaction

There are five main types of forex transaction:

    Spot - 48% of the market
    Swaps - 39%
    Forwards - 7%
    Options - 5%
    Futures - 1%

Making money

Most traders work in spot forex. This is where currencies are exchanged directly. Here's an example:

    You want to trade US dollars and Swiss francs
    The instrument for buying Swiss francs with US dollars is USDCHF
    You buy when the rate is 0.7700 and get 770 Swiss francs for $1,000
    You wait until the Swiss franc goes up
    You sell at a rate of 0.7690
    Your profit is one Swiss franc or $1.32
    You only had to invest $10 because you had 1:100 margin
    You have made a 13.2% profit

In the example above, the price changed by 10 points – a point is 1/10,000th of a currency unit. Prices normally change by between 80 and 150 points per day, so you can make large profits. If the price above had changed by 80 points, you would have made $10.56 for a $10 investment.

However, the exchange rate can also move in the wrong direction, in which case you will lose money. That's why it's important to analyse the market before you buy, and to keep a close eye on your open positions. You can also set stops, which place a sell order automatically when a specific exchange rate is reached. That way, you can lock in your profits and limit your losses.

When you first start forex trading, we recommend that you open a Cent Account with us. With a cent account, you can make trades for as little as two cents each. This is an excellent way to learn the forex market without taking significant risks.