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What is Forex Trading?

Forex is short for foreign exchange, also called FX and currency trading. It is a decentralised global market for trading in all the world’s currencies. It’s the world’s largest form of exchange and it trades around $4 trillion every day.

Since exchange rates are not fixed, but fluctuate based on the supply and demand of the various currencies, this gives opportunities to turn a profit.

Each currency has a currency code of three letters: GBP for British pounds, USD for US dollars, EUR for euros, and so on.

In a forex transaction you are betting on the value of one currency against another, so all trades involve two currencies – a currency pair, shown like this: GBPUSD. The currency on the left is the ‘base’ currency; on the right it’s the ‘counter’ currency. The FX rate shows how many units of the counter currency are required to purchase one unit of the base currency. For example, an FX rate of GBPUSD1.2441 means that 1 US dollar and just over 24 cents are needed to exchange for one British pound.

When you trade, the prices you are quoted will show a buy price (the bid) and a sell price (the offer), with the difference between them being the spread. The bid is the price at which the person you are trading with will buy the base currency (or sell the counter currency); the offer is the price at which they will sell you the base currency (or buy the counter currency).

Whether you want to buy the base currency or sell it depends on whether you think the currency will go up or down against its counter currency. For example, if you are looking at EURUSD and you think the euro will increase in value against dollar, then you buy EURUSD. Contrariwise, if you think the euro will decrease then you sell EURUSD.

You decide how much money you wish to trade, expressed in an amount per point. Usually a ‘point’ refers to the fourth number after the decimal point so in the case of GBPUSD1.2441 it’s the final number. In this example, if you want to trade £1 per point, and the GBPUSD rate goes up to 1.2442 then you make a £1 profit. If it goes down you make a loss.

The larger the movement, the bigger your profit (or loss).

Note that you are not actually buying or selling the currency, you are simply opening a speculative position on the change in value of the forex pair, and you realise your profit (or loss) when you close the position.

A forex trade uses leverage, which means you don’t have to provide the full value of the trade to open a position. Instead you put down a margin deposit at a fraction of the value. This is great if you make a profit, but it also means your losses could be a lot higher than the amount you have staked.

This is why it’s very important to use a ‘stop loss’ order. You decide how much you are prepared to lose if the market goes against you and set the stop loss accordingly. This caps your loss.

Forex trading can be carried out with either spread betting or CFD trading.

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