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What is forex trading?

Foreign currency
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Forex, or foreign exchange, trading involves exchanging one currency for another. There can be functional purposes to engage in forex trading, such as travelling abroad and needing to exchange dollars for the currency of the country you’re travelling to, but there can also be financial or speculative reasons to trade currencies.

Here’s some key information on forex trading, its history and trading strategies.

Key forex trading statistics

  • Average daily forex volume in North America during April 2021 was $966.7 billion, according to a survey from the New York Fed.
  • That showed a nearly 20 percent increase from April 2019 levels of $810.9 billion.
  • Global forex average daily trading volume was $6.6 trillion in April 2019, according to a triennial report from the Bank for International Settlements (BIS).
  • The U.S. dollar is by far the most popular currency in forex transactions, accounting for $5.8 trillion of the average daily volume in April 2019, the BIS found.
  • The next most popular currencies were the Euro at $2.1 trillion and the Japanese yen at $1.1 trillion, according to the BIS report.

What is forex trading?

Forex markets can be used to exchange one currency for another, and there are several reasons why this might be necessary. Businesses that operate in more than one country, financial traders and people looking to travel abroad all have reason to engage in forex trading.

Due to the vast needs for foreign exchange, forex markets tend to be the biggest and most liquid of any in the world, but some currencies can be volatile.

The history of forex trading

The trading of currencies has existed in some way for centuries. People have long needed a way to pay for goods and services, and different currencies have been a major part of that. But today’s more modern forex markets are a relatively recent creation.

  • In July 1944, representatives from 44 nations gathered in Bretton Woods, New Hampshire to establish a monetary system that would create exchange rate stability, prevent competitive currency devaluations and promote economic growth.
  • The Bretton Woods system became fully operational in 1958, with currencies being convertible, international debts settled in dollars, and dollars being convertible to gold at a fixed exchange rate.
  • In 1971, U.S. President Richard Nixon ended the dollar’s convertibility to gold after the amount of foreign-held U.S. dollars exceeded the U.S. supply of gold.
  • Following the collapse of the Bretton Woods system, countries were free to choose any arrangement for the exchange of their currency, except pegging it to gold. Currencies could be tied to another currency, a basket of currencies or be determined exclusively by market forces.
  • Today, forex trading is done mostly by banks on behalf of clients, and trading occurs 24 hours a day from 5 p.m. ET on Sunday through 4 p.m. ET on Friday. Individuals can even trade using an app on their phone.

The largest forex trading centers

Most forex trading occurs in London, followed by New York, Singapore and Hong Kong. Some thought the U.K.’s decision to leave the European Union would dent London’s spot as the largest forex market, but that has not proven to be the case.

Rank Country Average Daily Volume ($ millions) Share of forex market
1 United Kingdom 3,576,409 43.1 percent
2 United States 1,370,119 16.5 percent
3 Singapore 639,869 7.7 percent
4 Hong Kong 632,108 7.6 percent
5 Japan 375,505 4.5 percent
6 Switzerland 275,719 3.3 percent
7 France 167,123 2.0 percent
8 China 136,017 1.6 percent
9 Germany 124,448 1.5 percent

Source: BIS Triennial Central Bank Survey 2019. Average daily dollar volume in all other countries is  $1,003,271 million, or 12.1 percent of the total market share on a “net-gross” basis.

Forex trading strategies

Forex trading is fairly simple in concept, but that doesn’t mean you’ll make money trading currencies. If you’re just starting out, make sure to tread carefully and make sure you understand the trades you’re placing and how they can go wrong.

You can trade forex at many of the same online brokers that offer stock trading. Here are some strategies for beginners and more experienced traders.

  • Beginners: Many traders use technical analysis to plan their next moves, which involves looking at charts and price action to try to anticipate where a currency is headed next. Trend trading is a strategy that is good for beginners because it’s fairly simple to understand and is essentially a prediction that recent price trends will continue.
  • Intermediate: If you’re looking for a slightly more advanced approach, a carry trade may be a profitable option. A carry trade involves shorting a currency with low interest rates and buying a currency that pays higher rates. The Japanese yen is often used in this strategy because of the low interest rates in Japan. The trader then purchases a different currency to capture the difference in rates. But beware that exchange rates can move so that the gain in interest rates is wiped out.

How to get started with forex trading

Forex trading has similarities with other investment options, but there are a few things that make it unique.

  1. Open a brokerage account. Before trading any financial asset you’ll need to set up a brokerage account, which is easy to do online through places like Interactive Brokers or TD Ameritrade. Not all brokers offer forex trading, so be sure to check that a platform does so before opening an account. Funding the account is fairly straightforward and can be done through an electronic transfer or a physical check. Funding the account online usually takes a couple of days.
  2. Learn forex basics. Trading forex presents some unique challenges that you might not be familiar with if you’ve only traded stocks or ETFs. The variables that drive forex trading and changes in exchange rates are different from those that drive stock prices. You’ll likely need to pay more attention to the macroeconomic factors for the countries whose currencies you’re trading. Things like GDP growth, trading deficits and interest rates can play a big factor in exchange rates. Make sure to understand the key fundamentals before you start trading.
  3. Pick a strategy. Once you’ve got a grasp of the basics, pick which trading strategy you’d like to pursue. Will you use technical analysis to identify trends or follow more of a fundamental approach based on macroeconomic data? Both approaches can be successful, but it’s important to choose a strategy that makes the most sense for you.
  4. Start slowly. It’s best to go slow when you’re just starting out. There’s no need to shoot for the moon with your first trades. Start with small amounts as you’re learning so that any mistakes don’t wipe you out. As you gain more experience, you’ll be able to increase position sizes and recognize trends more quickly.

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Written by
Brian Baker
Investing reporter
Bankrate reporter Brian Baker covers investing and retirement. He has previous experience as an industry analyst at an investment firm. Baker is passionate about helping people make sense of complicated financial topics so that they can plan for their financial futures.
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