What Is Forex Trading?

Foreign exchange trading, or “forex trading,” is the buying and selling of currencies to take advantage of price fluctuations. It’s one of the largest financial markets in the world, with more than $6.6 trillion traded daily, yet it carries substantial risk. While forex trading can be profitable, it is mostly speculative, and most retail traders experience losses if they enter without understanding the market.

Here, we’ll give a brief overview of the history of foreign exchange, review why someone might want to trade currencies, explore the forex market as a whole, consider the pros and cons of forex trading, and list and define some of the more common forex trading terms. Finally, we’ll offer answers to some of the more commonly asked questions about forex trading.

Understanding forex trading

Currencies are required for global trade. If you travel or do business internationally, you must exchange your local currency for another. Forex trading allows investors to profit from changes in exchange rates by buying one currency while selling another.

Currency values fluctuate based on supply and demand. For example, if you buy euros with U.S. dollars, and the euro rises in value relative to the dollar, you can sell the euros for a profit. Traders can take long or short positions and often use leverage to amplify returns, though leverage can also magnify losses.

Someone might be interested in forex trading if they’re looking to capitalize on short-term exchange rate fluctuations. Forex traders also can conduct business with relatively low (or no) commissions and operate in a market open 24 hours a day, five days a week. Traders can take both long and short positions, and they can also employ leverage when desired. Although leverage can lead to outsized gains relative to initial investments, it can also lead to magnified losses.

Key features of forex trading for retail investors:

• Low or no commissions on trades
• Markets open 24 hours a day, five days a week
• Access to leverage to increase potential gains
• The ability to profit from both rising and falling currencies

Despite these features, forex trading is primarily speculative, so caution and proper risk management are essential.

History of forex trading

After World War II, the world economy was in shambles and entered a sustained period of rebuilding. To stabilize prices internationally, the United States created the Bretton Woods system — a monetary mechanism that pegged all international currencies to the U.S. dollar and the gold standard (within some margin of error). International currencies could then be easily converted to U.S. dollars without major price destabilization.

The Bretton Woods agreement met its demise in 1971, and currencies again began to float freely against one another. This created additional opportunity for traders to capitalize on exchange rate differences between currency pairs. Increasing usage of computer technology allowed for supply and demand to truly dictate the price of any given security and to efficiently swap currencies at large amounts and/or with the use of leverage.

Soon enough, retail traders gained access to low or no-cost trading platforms that made forex trading possible at the personal level. People are now able to trade currencies from their phones at any time of day with very few restrictions. Although this access has created tremendous opportunity, there still exists the possibility for substantial losses when trading currencies at size.

The forex market

To trade currencies in the forex market, it’s important to understand how they are quoted and the different ways trades can be executed. Currencies are always traded in pairs, with one currency exchanged for another, and trades can take place in the spot, forward, or futures markets, depending on whether you want immediate settlement or a contract for the future.

Currency Pairs

Currencies are listed using three-letter codes, like USD (U.S. dollar), EUR (euro), and JPY (Japanese yen). Forex trades involve currency pairs, where the first is the “base currency” and the second is the “quote currency.”

• Example: EUR/USD = 1.06 means 1 euro costs 1.06 U.S. dollars.

The four major pairs — EUR/USD, USD/JPY, GBP/USD, and USD/CHF — dominate trading volumes globally.

Spot, Forward, and Futures Markets

• Spot Market: Trades settled immediately at current exchange rates.
• Forward Market: Contracts to buy or sell a currency at a predetermined rate on a future date; commonly used for hedging.
• Futures Market: Standardized contracts traded on exchanges and marked to market daily.

Pros and cons of forex trading

Review the table below to learn about some of the pros and cons of foreign exchange trading:

Forex terms to know

Some of the more common currency terms include:

• Currency pair: Two currencies listed in succession, representing the current exchange rate between the two. The first listed currency is known as the base currency, and the second is known as the quote or price currency. A currency pair reflects one currency’s value versus another’s value.
• Bid-ask spread: The difference between the current bid and ask prices for a currency (or other listed security). The bid price is the highest price a buyer will pay for a particular currency (and at a given size), while the ask price is the lowest price a seller will accept for the same currency.
• Pip: The smallest unit of measurement in currency exchange. It is most directly defined as 1/100th of 1%, or one basis point. In numerical terms, it’s presented as either .0001 or .01%.
• Lot: A standard lot represents 100,000 units of currency. A mini-lot represents 10,000 units, while a micro-lot represents 1,000 units.
• Leverage: Another way of saying “borrowed money” in forex trading. Leverage allows a trader to take larger positions in a particular currency, which allows for magnified gains, or, in the opposite case, magnified losses. In other words, traders can be liable to lose more than their initial investment if they decide to employ leverage.
• Margin: A good-faith deposit with a broker that allows a trader to take positions in one or more currencies. If the value of the trader’s positions falls below a certain level, they will need to replenish their margin deposit.
• Sniping and hunting: Buying and selling currencies near a specific price point to maximize profit-taking opportunities.

Getting Started Safely

Forex trading can be exciting, but it’s also high-risk, especially for retail traders. Success depends on education, discipline, and careful risk management. Here are key steps to get started safely:

1. Open a demo trading account

Most brokers offer demo accounts that let you trade with virtual money. This allows you to practice strategies, understand how trades are executed, and get comfortable with the platform without risking real capital. Use this time to track performance, experiment with different currency pairs, and test risk management techniques.

2. Understand leverage and use stop-loss orders

Leverage lets you control larger positions with a small amount of capital, but it can magnify both gains and losses. Before trading with real money, know how much leverage you’re comfortable using and always set stop-loss orders to automatically close a position if losses reach a predetermined level. This helps protect your account from sudden market swings.

3. Learn how economic events affect currency prices

Currency values are influenced by interest rates, inflation, employment data, geopolitical events, and central bank policies. Following economic calendars and understanding the potential impact of major announcements can help you make more informed trading decisions and avoid unnecessary surprises.

4. Choose a regulated broker

A reputable, regulated broker provides security for your funds, transparency in pricing, and reliable trade execution. Make sure the broker is licensed by a recognized financial authority and offers protections such as segregated client accounts.

5. Develop a trading plan and stick to it

Set clear goals, determine your risk tolerance, and outline how much capital you are willing to risk per trade. Avoid impulsive trades and maintain discipline, as emotional decision-making is a common reason retail traders lose money.

By taking these steps, new traders can reduce risk, build confidence, and approach forex trading with a structured, informed strategy, increasing the likelihood of long-term learning and success.

The bottom line on forex trading

It’s definitely possible to make money by trading currencies. It’s been done before, and it will continue to happen. However, most foreign currency trading is done successfully by large trading institutions that can access global markets instantly, efficiently, and cost-effectively. Institutions also have access to significant amounts of leverage, which can help to amplify profits when trades go right.

The forex trading game for retail traders is a different animal entirely. Because there’s such a focus on short-term profits, you’ll need to be heavily dialed into minute-to-minute price changes within currency pair markets to achieve any success. And, even if you do have the determination, a lot of external variables have to fall favorably for you to make money over any meaningful period of time.

The Motley Fool stands behind our view that long-term investing is the best way to generate robust wealth. A focus on short-term, speculative strategies has the potential to make you rich, but it also has the potential to cause catastrophic and irreversible losses. Be sure that you’re able to detect the difference before putting up any of your hard-earned money.