What is Forex Trading?

Forex, or the Foreign Exchange, is the world’s largest financial market, operating 24 hours per day, five days per week. In very simple terms, a Forex trader buys and sells different global currencies, based on their comparative worth against other currencies. The idea is to buy currencies that will increase in value compared to the currency you’re selling, in order to make a profit (getting a favourable exchange rate).

These trades are always completed in pairs. When one currency is purchased, another has to be sold. For example, in a GBP/JPY trade, you would sell British Pounds and buy Japanese Yen. The currency you’re selling (in this case GBP) is called the base currency, and the currency you’re buying (JPY in this case) is called the quote currency or the counter currency.

Forex Trading is More Common Than You Think

If you’ve ever travelled internationally or done business in a currency other than your own (like placing an order from a U.S. website when you live in London), you’re already familiar with the foreign exchange and exchange rates – you just took part on a smaller scale than many investors looking to make a profit.

Let’s look at a small scale example: Assume you’re starting with a GBP base currency, and you’ll be travelling to the U.S. on holiday. You can’t use your home currency when in the States to make purchases (meals, transportation, etc.), so you need to convert GBP to USD. At the time of your trade, the GBP/USD exchange rate is 0.641396. What does this mean?

If you wanted to buy USD $1000 for your trip, it would cost you GBP £641.396. A similar exchange would happen if you booked your hotel room in the U.S. early directly through that hotel (paying with your credit card). Credit card companies handle the exchange rates / trades for you, and often charge a reasonable fee compared to some banks or other businesses that will convert your cash, traveller’s cheques, or other home currency.

When you return home, you’ll partake in a similar transaction, converting any remaining USD to GBP. In this case, we’ll assume the USD/GBP exchange rate is 1.55909. It would therefore cost USD $1559.09 to purchase GBP £1000, or USD $1.55 for every British Pound Sterling on conversion.

Forex Trading for Profit

While you participate in the foreign exchange while travelling, you probably aren’t doing it with profit-seeking motivations – you’re doing it out of necessity. Forex traders, on the other hand, trade global currencies with the intention of making money (and retail traders are required to work through brokers).

Let’s go back to the GBP/USD exchange rate of 0.641396 and the USD / GBP exchange rate of 1.55909. In this case, a British Pound Sterling has a higher value than a U.S. Dollar in a 1:1 ratio. If the value of the USD is expected to drop, Forex traders in possession of USD might sell those dollars in exchange for GBP, knowing the value of GBP in relation to the dollar will increase.

Therefore, if an investor had USD $100000, they could exchange it for approximately GBP £64140. If the value of the dollar continued to decrease compared to the pound, the GBP/USD exchange rate might then become .495592 – then you could buy that same USD $100000 with only GBP £49559.20, earning you a profit of £14580.80 over your original USD $100000 investment. Because of the 24-hour Forex markets, trading on the foreign exchange can be particularly risky, and currency values can fluctuate at any time due to world events.

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