Learning Forex (Preschool) - What is Forex?

Forex trading is the simultaneous buying of 1 currency and selling of another.

When you trade in the forex market, you buy or sell in currency pairs through a “forex broker” or “CFD provider”.

An exchange rate is the relative price of 2 currencies from 2 different countries and it fluctuates based on which currency is stronger at the moment.

Categories of currency pairs:

• The “major pairs": always include the USD
• The “cross/minor pairs“: do NOT include the USD. Crosses that involve any of the major currencies
• The “exotic pairs“: consist of 1 major currency and 1 currency from an emerging market (EM).

There are only 7 major currency pairs.

Compared to the minors and exotics, the price moves more frequently with the majors, which provides more trading opportunities.

• EUR/USD
• USD/JPY
• GBP/USD
• USD/CHF
• USD/CAD
• AUD/USD
• NZD/USD

The majors are the most liquid in the world.

Liquidity is used to describe the level of activity in the financial market.

The more frequently traded something is the higher its liquidity.

While not as frequently traded as the majors, the crosses or minors are still pretty liquid and still provide plenty of trading opportunities.

The most actively traded crosses/minors are derived from the three major non-USD currencies: EUR, JPY, and GBP.

• EUR/CHF
• EUR/GBP
• EUR/CAD
• EUR/AUD
• EUR/NZD
• EUR/SEK
• EUR/NOK
• EUR/JPY
• GBP/JPY
• CHF/JPY
• CAD/JPY
• AUD/JPY
• NZD/JPY
• GBP/CHF
• GBP/AUD
• GBP/CAD
• GBP/NZD

However, there are also some other pairs that still included in crosses or minors such as:

• AUD/CHF
• AUD/CAD
• AUD/NZD
• CAD/CHF
• NZD/CHF
• NZD/CAD

Exotic currency pairs are made up of one major currency paired with the currency of an emerging economy, such as Brazil, Mexico, Chile, Turkey, or Hungary and many others.

Basically, an exotic currency pair includes one major currency alongside an exotic currency. 

Due to the overall lower degree of liquidity, exotic currency pairs tend to be far more sensitive to economic and geopolitical events.

For example, a political scandal or unexpected election results can cause an exotic pair’s exchange rate to swing violently.

The bulk of forex trading takes place on what’s called the “interbank market“. The forex market has neither a physical location nor a central exchange.

The forex market is considered an over-the-counter (OTC) market because the entire market is run electronically, within a network of banks & non-bank financial institutions (NBFIs), continuously over a 24-hour period.

According to the International Monetary Fund (IMF), the USD comprises roughly 62% of the world’s official foreign exchange reserves.

Foreign exchange reserves are assets held on reserve by a central bank in foreign currencies.

The main functions of the forex market are:

• To transfer funds from 1 currency of a country to another currency.
• To provide short-term credit to finance trade between countries.
• To avoid or “hedge” against foreign exchange rate fluctuations from when a transaction is initiated & when payment is received.
• To speculate.

Most currency trading is based on speculation. Most of the trading volume comes from traders that buy & sell based on the short-term price movements of currency pairs.

The forex market is relatively very liquid but the market depth could change based on the currency pair & time of day.

Among the financial instruments, the most popular ones are:

• retail forex
• spot FX
• currency futures
• currency options
• currency exchange-traded funds (or ETFs)
• forex CFDs
• forex spread betting

Other financial instruments like FX swaps and forwards are not covered since they cater to institutional traders.

A currency future is a contract that details the price at which a currency could be bought or sold and sets a specific date for the exchange.

Currency futures were created by the Chicago Mercantile Exchange (CME) way back in 1972

Since futures contracts are standardized and traded on a centralized exchange, the market is very transparent and well-regulated.

This means that price and transaction information are readily available.

Institutional traders use this

An “option” is a financial instrument that gives the buyer the right or the option, but not the obligation, to buy or sell an asset at a specified price on the option’s expiration date.

If a trader “sold” an option, then he or she would be obliged to buy or sell an asset at a specific price at the expiration date. Just like futures, options are also traded on an exchange.

However, the disadvantage in trading FX options is that market hours are limited for certain options and the liquidity is not nearly as great as the futures or spot market.

The spot FX market is an “off-exchange” market/an over-the-counter (“OTC”) market that operates 24 hours a day.

A spot FX transaction is a bilateral (“between two parties”) agreement to physically exchange one currency against another currency.

The agreement is a contract. This means this spot contract is a binding obligation to buy/sell a certain amount of foreign currency at a price that is the “spot exchange rate”/the current exchange rate.

The delivery of what you buy/sell should be done within 2 working days and is referred to as the value date or delivery date.

Institutional traders use this

There is a secondary OTC market that provides a way for retail traders to participate in the forex market.

Forex trading providers trade in the primary OTC market on your behalf. They find the best available prices and then add a “markup” before displaying the prices on their trading platforms.

Retail forex brokers let you trade with leverage which is why you can open positions valued at 50 times the amount of the initial required margin.

Retail forex trading is considered speculative or make bets on (and profit from) the movement of exchange rates.

Retail traders use this

A CFD is a contract, typically between a CFD provider & a trader, where 1 party agrees to pay the other the difference in the value of a security, between the opening and closing of the trade.

Trading forex CFDs gives you the opportunity to trade a currency pair in both directions. You can take both long & short positions.

If the price moves in your chosen direction, you would get profit, and if it moves against you, you would get loss.

Retail Forex use this to get profit for retail traders