This forex introduction provides an overview of what forex is and how to trade it. Topics covered include currency pairs, how to make money, the bid/ask spread, pips and pip value, lot sizes, market hours, leverage, and rollover. Don’t know what some of those things are? No worries, you will soon, and knowing about all these things is important if you want to trade forex.
The retail forex market offers many opportunities, yet it’s a dangerous and confusing place for those who don’t understand how it works. The forex, or foreign exchange market, is where the world’s currencies are traded. A currency is always traded relative to another currency.
When we see “EUR/USD,” the corresponding rate is the value of one currency relative to the other. Let’s look at an example.
Assume the EUR/USD is trading at 1.3600. The easiest way to understand currencies is to view the first currency, in this case the EUR, as 1. So the rate, 1.3600, is how much of the second currency (USD in this case) it takes to buy 1 EUR.
The first currency in the pair is our directional currency on a chart. If you open a EUR/USD chart (in your trading software or on a free platform such as TradingView.com) and the price is rising then the EUR is increasing in value relative to the USD. If the rate is falling then the EUR is losing value against the USD.
If reading about all this seems a little confusing, and you want someone explaining it in video format, check out the Forex Introduction Course. It gives you everything you need to easily understand forex and start trading this exciting market.
Currency Pairs to Trade
There are many symbols representing the currencies of the countries (and zones) around the world, although for trading purposes there are only a handful you really need to be aware of.
These symbols and their corresponding currencies are listed below. For most short-term or active traders these are the currencies to focus on:
USD = United States Dollar
EUR = Euro (Euro Zone countries)
JPY = Japanese Yen
GBP = British Pound
CAD = Canadian Dollar
AUD = Australian Dollar
CHF = Swiss Franc
NZD = New Zealand Dollar
Remember, each currency is traded relative to another currency, creating a pair. The following are heavily traded pairs and are therefore the most commonly used for speculative purposes.
These are the most heavily traded currencies in the world, and the ones which most forex traders end up trading.
When I day trade, I ONLY trade the EURUSD. I trade for 1 to 2 hours per day, and you can see my full method on how to do it in the EURUSD Day Trading Course.
The list above shows currency pairs that are used for both day trading and swing trading. This isn’t to say there isn’t movement or profit potential in other currency pairs that aren’t listed here. The list simply shows pairs that are heavily traded globally, and therefore acceptable for day or swing trading.
In addition to the above pairs, swing traders can also trade the following pairs, which include combinations of all the major currencies: EUR, GBP, AUD, NZD, JPY, CAD, CHF, and USD.
These pairs can also be day traded, but only if your broker offers low spreads and the current volatility warrants trading in the pair. The spread and volatility are discussed later.
For additional reading, and a video, on this topic, see Which Forex Pairs to Trade – Day Trading and Swing Trading. It includes some other pairs for swing traders looking to capitalize on once they are comfortable with the above.
Buying, Selling, and Short Selling
In the forex market, one currency is always traded relative to another. If you buy the USD/CAD, you’ve bought the USD and sold the CAD. Traders will often say they’re “long” the currency that was bought. Similarly, if you sell the USD/CAD, you’ve sold the USD and bought the CAD. This is commonly referred to as being “short” or “shorting” the USD/CAD.
Buying and selling occur on every transaction. This is confusing at first, yet remember the first currency listed in the pair is the directional currency on the chart. If the price of the EUR/USD is rising and you think the upward direction will continue, you’ll buy the EUR/USD hoping to sell it at a higher price later.
If the price of the EUR/USD looks like it’s heading lower, then you sell the EUR/USD hoping to close the position for a profit at a lower price later on.
In the forex market, traders buy or sell (short) at any time, without restriction, and can thus make (or lose) money whether a currency pair rises or falls in value.
The Forex Bid/Ask Spread and Pips
The EUR/USD is a popular trading pair, and does the highest trading volume most days. The EUR/USD generally has about a 1 pip spread with most brokers who don’t charge commissions. The spread is how these brokers make their money. If the broker charges a commission per trade, then the spread may be 0.1 to 0.5 pips.
If the bid price is 1.36010, with a one pip spread the ask or offer would be 1.36020. For a broker with a 0.1 pip spread, if the bid is 1.22013 then the ask/offer will be 1.22014.
A pip is a fourth decimal place in most currency pairs. In the JPY pairs, it is the second decimal place. Most brokers show currency pair prices to the fifth decimal (or 3 decimal places for JPY pairs). This fifth decimal (or third with JPY) is a fractional pip. There are 10 fractional pips within a pip.
If the bid price increases from 1.15061 to 1.15071, the price has increased by 1 pip, because the fourth decimal has increased by 1.
If you want to buy a currency pair you’ll have to buy at the ask/offer price, and sell at the bid price. If the EURUSD bid is 1.36032 and the offer is 1.36041, if you want to go long (“long” means “buy”) you pay the 1.36041 rate.
If you sell immediately after going long, your sell price is 1.36032. You lose 0.9 pips, in this case, without the currency pair even moving.
The spread is equivalent to a commission being charged by a broker. In the forex market, some retail brokers don’t charge commissions, rather they force you to pay the spread. This is how forex brokers make their money.
Brokers that charge a commission typically should have smaller spreads. The commission is between $1 to $7 per $100,000 traded. Choose your broker wisely, because as you can see, commissions can vary considerably. Also, consider the spread. The smaller the spread the better.
Commissions and the spread are both costs; we want to minimize both or find the lowest total cost when adding both costs together.
Also read, Don’t Take the Deposit Bonus From a Forex Broker.
Forex Lot Sizes – Micro, Mini, Standard Lots
A “lot” is a standardized quantity of something. In forex, we trade a specific quantity of currency. The pre-established lot sizes are called micro, mini, and standard.
A standard lot is 100,000 worth of currency. When plugging position size into a forex trading platform, a standard lot is 1.
For example, in the order window, if you wanted to buy 100,000 (Euros) of the EUR/USD, then your position size would be 1. Lots are based on the first currency listed in the pair. So if you buy the GBP/USD, you are buying 100,000 GBP. If you sell the USD/JPY, you are selling 100,000 worth of USD.
A mini lot is 10,000 worth of currency. A mini lot is 0.1, when plugging size into a forex trading platform.
A micro lot is 1000 worth of currency. A micro lot is 0.01, when plugging in position size.
Most brokers allow you to trade in any of these lot sizes. If your account is under several thousand dollars, then you definitely want a broker that will allow you to trade micro lots.
Two of my preferred brokers (for non-US residents) are FXOpen. I also like VantageFX, but they no longer accept Canadian or US clients. I am also using FXCC, and like it for the small spreads and no commissions.
Forex Pip Value
A pip has a value attached to it, and that value will vary depending on the currency pair you’re trading, how many lots you are trading, and your account currency.
The pip value of certain pairs fluctuates as the rate of the pair changes. This means drastic changes in the rate of a currency pair will greatly affect the pip value, which must be considered when calculating risk and ultimately position size (the quantity you choose to buy or sell).
For other pairs, the pip value will always stay the same.
If you have a USD account, any pair where the USD is listed second will have a pip value of $0.10 for a micro lot, $1 for a mini lot, or $10 for a standard lot. Therefore, if you have a USD account, and you are trading the EURUSD, then each pip of movement will make or lose you $0.1 for every micro lot (1,000 worth of currency) you own.
If you have a CAD account, any pair where the CAD is listed second will have fixed pip values of CAD$0.10, CAD$1, and CAD$10 for micro, mini, and standard lots respectively.
Same goes for any other account currency. If YOUR account currency is listed second, then the pip value for that currency is 0.10, 1, and 10 in your own currency for a micro, mini, and standard lot.
When your account currency isn’t listed second, things get a little more complicated. Check out the Definitive Guide on Forex Pip Values for a full explanation of calculating pip values for all account types and pairs.
And the easiest way to calculate pip values is to use a pip value calculator like the one at MyFxBook. Fill in your account currency (type of currency you deposited), how much you want to trade (just input 1, since the list shows the pip value for micro, mini, and standard lots), and the list fills in with the pip values for all the pairs.
Pip values are important because it is a required element of our position sizing formula (how much currency we decide to trade) as pip values affect our risk and profit potential on a trade.
Forex Market Hours and News
The forex market is open 24 hours a day from 5 PM EST Sunday to 5 PM EST on Friday.
There are many opportunities to trade throughout the day, yet not all strategies will work at all times of the day.
The chart below shows when various markets are open throughout the day in different parts of the world, based on the 24-hour clock.
To see when markets are open based on your own time zone, go to ForexMarketHours. From the drop-down menu select your time zone and click “Go.” The chart will update and provide the open and close times of the major financial centers around the world based on your time zone. Daylight Savings may affect these hours in your area at certain times of the year.
The markets shown in the figure above are high-impact markets. When these markets are open it greatly affects the currency pairs associated with them. I recommend trading currency pairs that have at least one currency (from within the pair) “open for business” when day trading.
For example, the EUR/USD currency pair is most active during the London and/or New York sessions. It’s likely to be especially active during the four-hour overlap period when both these markets are open and trading the pair. During the London and/or US session is the ideal time to day trade this pair. When London and New York banks are closed for business, there’s less opportunity.
Near 5 pm EST each day (New York close) spreads tend to widen considerably. Take this into account when holding positions through this period. The spreads can get very wide heading into a weekend around this time, and when markets re-open the following week. For more on how to navigate this time of day, see Hold Forex Trades Through the Weekend, or Close Them?
Forex Economic News Announcements
Forex market prices react significantly to planned economic news releases (and surprise economic events as well).
Economic news is released at scheduled times throughout the week. Forex brokers often provide a news feed that alerts you when news is coming out. Also, many sites display a global economic calendar so you’re aware of all news events beforehand, and can prepare for news that has a market impact.
Only being aware of one country’s news events isn’t enough. Make sure the economic calendar you’re viewing shows all significant global news events that may affect the currency pair you’re trading.
A significant news event for the Eurozone is likely to impact not only the EUR/USD, but also the USD/CHF, GBP/USD, and potentially others.
Here’s an economic calendar from Investing.com that shows scheduled economic events in all the major currencies. Be sure to adjust the time zone. Events marked “High” importance (usually colored red) deserve special attention. I like this calendar because if you have a free account, you can adjust the Filters to see only the countries you are interested in, and the expected impact of the news. I only care about high-impact news, so I have it set so those are the only ones that show up for the countries I have selected. If you are day trading, you may also want to step aside for medium-impact news, as it can cause large price spikes as well.
Stop day trading at least two minutes before the high-impact (and even medium-impact news) news event. After the high-impact news is released wait a minute or so before day trading again. This gives the market time to choose its direction based on the news, and we avoid getting caught in wild price swings which could cause significant losses.
If you are swing trading, decide whether you will exit your position before high-impact news is released. If the price is close to the stop loss, exiting may be prudent as the news can cause price gaps where the price jumps through the stop loss order and we end up taking a larger loss than expected (this is why we also exit day trades prior to major news). A stop loss is an order that gets us out of a trade at a pre-determined price.
Leverage is what makes the forex market attractive. The price moves of currencies are typically quite small, compared to stocks for example. So leverage is what makes trading those small percentage moves worthwhile. Leverage is what allows me to make a couple of percent (or more) a day while day trading, even though the actual movements I am trading are a fraction of that.
Leverage is borrowing money and adding it to your own so potential profits are increased. While no one is likely to borrow money to increase losses, this also occurs. All transactions are magnified, both good and bad, when leverage is employed. Let’s look at a quick example of what leverage is:
Assume you have $10 and are offered a trade where you can make 10%. You accept this trade, make 10% and now you have $11 (attained by $10 + ($10 x 0.1) = $11).
Now, let’s assume you went to a friend and asked to borrow an additional $90 for making the trade. You now have $100, and accept the trade making 10% on the full $100. You now have $110 (attained by $100 + ($100 x 0.1) = $110).
You return $90 to your friend and are left with $20. Based on your original $10 investment, the return on your money is 100% (instead of only 10%)! You doubled your original investment by borrowing and making money on the larger amount.
If the trade doesn’t go your way, we need to control the loss. You have $100 in the trade, so if the price starts going against you, you can cut the loss at any time, such as at $99.90, or $99. Because remember, you only have $10, so you want to keep losses to a small fraction of that, even though you are trading with $100, for example.
The forex market allows you to do this. FX (forex) brokers commonly give from 1:1 up to 500:1 leverage. This means that for every one dollar you deposit you can receive up to $500 in capital to trade with. This is beginning to change due to stricter regulation. For instance, in the US traders are limited to 50:1 leverage, which is still more than most traders will need. Other countries have also followed suit, and some have even restricted leverage to 30:1 or less.
Let’s assume you choose to have 50:1 leverage in your account, and you deposit 1,000. You’ll have 50,000 in total buying power you can make money off of. The account currency doesn’t matter; whatever currency you deposited into your account is the currency of your buying power.
To open a position worth 10,000 means you put up 200 in margin (with 50:1 leverage, because 10,000 / 50 = 200). This is your good faith assurance of the trade, and as long as you maintain 200 in unused capital in your account that trade can stay open (and of course, you can exit at any time you wish, whether with a profit or a loss).
If you take too large of a position using leverage, and the market moves quickly against you, you could lose more money than you have in the account. If this occurs, you’ll need to deposit more into the account to make up for the loss.
Certain brokers have provisions and safeguards which prevent this from happening, but it’s important to understand the legalities of using leverage and the risks associated with it. Big losses should never, ever, happen. If you manage your position size and don’t hold short-term trades through high-impact news events, the likelihood of a much larger loss than expected is minimal.
There’s generally no interest charged for using leverage in forex trading, although there is rollover (discussed next). Some brokers do charge for the use of leverage though, and it’s also possible to open accounts that have no interest or rollover. Be sure to read through all the legal documents when opening an account as each broker may have slightly different policies.
For a guide on how much leverage to use, see How Much Forex Leverage to Use.
Forex Daily Rollover
Brokers commonly “rollover” positions in your account. This is so the trade isn’t actually “settled,” which would require taking possession of the currency you purchased. Since nearly all retail traders are trading for speculative reasons, and not because they wish to actually receive the physical currency they purchased, roll-over is an automatic process.
For example, when you buy a standard lot of USD/CAD you are agreeing to buy $100,000 worth of USD. The trade is now done. You have bought USD and will give someone else the equivalent amount of CAD. But you may only have $5,000 in your account. You don’t actually want $100,000 delivered to you (nor to deliver CAD to someone else). You just want to bet on the direction the price will go to potentially profit. Therefore, the broker doesn’t let that trade “settle”. Instead, they keep the position open and reset it each day so that you don’t need to take or deliver physical currency.
This resetting of the position is called Rollover. Rollover means that each day you’ll be credited or debited the difference in the interest rates between the currencies in each pair you’re holding. This isn’t interest on the leverage your broker has provided to you.
If one country has an interest rate of 4% and another has a 2.5% interest rate, this difference is credited or debited from your account depending on if you’re long or short the higher interest rate currency, respectively.
Rollover is credited or debited each day at 5 PM Eastern time. It doesn’t matter if the position is open for two minutes or 23 hours; a position held at 5 PM is considered to be held “overnight” and is subject to an interest rate credit or debit.
Day traders should be aware of this, as holding a position for only a few moments around 5 PM can be an advantage or disadvantage depending on what the position is. Spreads widen around 5 pm, and there can be gaps and volatility, especially on Friday, as discussed in the section above.
Let’s look at an example of how this works each day. Say you buy the GBP (British Pound) and sell the USD (United States Dollar). In other words, you buy the GBP/USD pair. Assume the following interest rates in these economies: GBP = 4% and USD = 1%. There’s a 3% interest rate differential.
If you hold this position for an entire year (and interest rates don’t change) you’ll make approximately 3% interest on the value of the position. The value of the position is the full position, not just the margin that is used to maintain the position. Since markets fluctuate, the interest you receive won’t be exactly 3%, but is a rough approximation.
If you go short the GBP/USD (sell GBP, the higher interest rate, and buy USD, the lower interest rate) you’ll lose, or be debited, roughly 3% interest on the full value of the position if you hold it for a year.
When you use leverage, the effect of roll-over is substantially magnified. Assume for a moment you buy $10,000 worth of the GBP/USD and receive 3% in interest per year for holding the position. That’s $300 per year in interest income. But you’re not required to put up the entire $10,000. If you use 100:1 leverage, you’re only required to put up $100 of your own funds for the trade. Therefore, interest alone gives you a 300% return on invested capital because of the use of leverage—you get $300 for your $100 investment.
This is referred to as a Carry Trade, and there are specific strategies for capitalizing.
This also works in reverse though. If you’re short the GBP/USD in this example, your capital is rapidly depleted as you’re debited the interest rate differential each day. About one-third of the way through the year, even if the exchange rate hasn’t moved against you, you’ll have lost $100 due to leverage. If you hold the position an entire year, you’ll lose about $300 even if the exchange rate doesn’t move significantly against you.
Of course, the exchange rate is always moving, and therefore the trend of the currency must be considered when making trades as well. Trading decisions shouldn’t be solely based on rollover, as movement in the exchange rate can easily offset any gains or losses accrued because of rollover.
Brokers provide up-to-date information on how much the credit or debit will be if you hold a position overnight. Therefore, you don’t need to calculate anything; your broker should provide you with all the information you need. Rollover, like the spread, is a situation where brokers take a bit for themselves, so rollover rates vary from broker to broker.
Credits and debits occur automatically and no action is required on your part. Every time you hold a position overnight, you’ll see a credit or debit appear in your account activity.
Keep in mind the currency markets are fluctuating all the time, so the credits and/or debits are separate from capital gains made on the movement of the currency. For tax purposes track interest and capital gains separately—this should be easy to see in your account history report. Tax laws vary by country and region; consult a tax professional on how to report your forex interest and capital gains in your region. If you are a day trader, all gains generally need to be reported as regular income, so you only need to track how much you made (capital gains and interest are all the same thing in this case).
Since banks/markets are closed on Saturday and Sunday, the interest for these days is made up on Wednesday (usually). Positions held on Wednesday at 5 PM EST are subject to three days worth of interest credits or debits.
Interest rates change over time. Watch for changes in interest rates, as a change in these rates shifts the bias of buyers and sellers, both in the short-term and the long-term.
Forex Introduction Final Word
Here is some additional reading as you start your forex journey:
How Much Money You Need to Trade Forex
If you want to learn more about forex trading, check out the Forex Introduction Course. It has everything you need to get started and feel comfortable with trading forex.
If you are interested in day trading and want strategies and a method for creating an income stream in under 2 hours per day, then check out the EURUSD Day Trading Course.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage. This article contains affiliate links.
I'm an experienced forex trader and enthusiast with in-depth knowledge of the concepts discussed in the provided article. I've actively participated in the forex market, implementing various strategies and gaining practical insights into currency trading.
Now, let's delve into the key concepts covered in the article:
Currency Pairs and Exchange Rates:
- Currencies are traded in pairs, and the exchange rate reflects the value of one currency relative to another.
- Example: EUR/USD trading at 1.3600 means it takes 1.36 USD to buy 1 EUR.
Major Currency Pairs:
- Commonly traded pairs include EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, NZD/USD, EUR/JPY, GBP/JPY.
- EUR/USD is emphasized as a day trading preference.
Buying, Selling, and Short Selling:
- Buying a currency pair means buying the first currency and selling the second.
- Selling a currency pair involves selling the first currency and buying the second.
- Short selling refers to selling a currency with the expectation that its value will decrease.
Bid/Ask Spread and Pips:
- Spread is the difference between the buying (bid) and selling (ask) prices.
- Pip is the smallest price move in a currency pair, typically the fourth decimal place (except for JPY pairs where it's the second).
Forex Lot Sizes:
- Standard lot: 100,000 units of the base currency.
- Mini lot: 10,000 units.
- Micro lot: 1,000 units.
- Lot size is crucial for risk management.
- Pip value varies based on the currency pair, number of lots traded, and account currency.
- It determines potential profit or loss in a trade.
Forex Market Hours:
- The forex market operates 24 hours a day from Sunday 5 PM EST to Friday 5 PM EST.
- Active trading times vary, with certain currency pairs more liquid during specific market sessions.
Forex Economic News:
- Economic news releases impact currency prices.
- Traders should be aware of scheduled economic events globally, not just in one country.
- Leverage magnifies trading positions.
- Example: 50:1 leverage allows trading $50,000 with $1,000.
- Leverage enhances both profits and losses.
Forex Daily Rollover:
- Rollover occurs when positions are automatically extended to the next trading day.
- Interest rate differentials between currencies affect rollover credits or debits.
This comprehensive overview covers essential aspects of forex trading, from basic concepts to risk management and market analysis. If you have any specific questions or need further clarification on certain topics, feel free to ask.