How does the currency market work?

Forex trading has become very popular among retail traders over the last decade, thanks to technological advancements and low barriers to entry. If you are interested in joining in on the Forex action, but don't know how the market works, here's an introduction to help you decide if Forex trading is right for you.

What is the Forex market?

The Forex market, or Foreign Exchange market, is the market where you trade currencies, such as the US Dollar (USD), the Euro (EUR), and the Rand (ZAR). Currency pairs are usually classified into 3 main categories: the majors (pairs that include the currencies of the world's largest economies), the minors (pairs that include currencies of important countries, except for the USD), and the exotics (a major currency and a currency of a developing economy).

The Forex market is one of the largest and most liquid markets in the world. According to the Bank for International Settlements (BIS), there are 6 trillion dollars exchanged every day on this market. This liquidity and high trading volume are just a couple of reasons many traders decide to invest in this market.

How does the currency market work?

When looking at a currency pair quotation, you will see that there are always two currencies - a base currency (the one on the left) and a quote currency (the one on the left). With the USD/ZAR Forex trading pair, for instance, the USD is the base currency, and the ZAR is the quote currency.

If the quotation shows that the USD/ZAR = 14.6072, then it means that for 1 USD you can get 14.6072 ZAR. When the exchange rate moves up (USD/ZAR = 14.6073) or down (USD/ZAR = 14.6071), you can see this change in the last decimal of the quote – this is called a Pip.

Forex trading is always done in pairs, which means that you have to buy one currency and simultaneously sell another one. Depending on your trading scenario, you can buy a currency pair (buy the base currency and sell the quote currency) if you think the pair will move up, or you can short-sell the currency pair (short-sell the base currency and buy the quote currency) if you think the pair will go down.

How can you trade the Forex market?

To take advantage of Forex trading, you first need to find a Forex broker that offers lots, mini-lots or micro-lots to trade currency pairs and other services in your country. For example there are platforms catering to traders in South Africa as well as wider sub-Saharan Africa. To select the right broker, you need to compare trading costs, payment methods available, other financial assets you can invest in, as well as trading tools and platforms offered.

Your decision should also be based on your trading strategy. How will you analyze the markets (fundamental vs technical analysis)? Which trading style will you adopt (scalping, day trading, swing trading)? Do you want to do automated trading or discretionary trading? What kind of trading tools do you need to implement your trading strategy? In the end, it all comes down to determining what you need to be profitable trading the Forex market.

Final Word

Forex trading is one of the most popular markets to trade. It is easy to start, and you can take advantage of a market that is open 24/5. All you need is knowledge of what makes the market move, a profitable trading plan, the right FX broker, and a good Internet connection.