Forex market basics

Introduction: what is the forex market?

You will certainly have heard of the forex market, the world’s largest and most liquid financial market, but what is forex, and how does it work? Foreign exchange, usually abbreviated to forex, is the act of converting one currency for another. Any time you travel abroad or make a purchase from a foreign country, you need to exchange one currency for another.

A complex market

Different parts of this gigantic market – over $7 trillion in daily trading volume – act very differently, from small-scale retail purchases for holidays to giant hedging operations by international banks. Forex CFD traders access the market using contracts for difference, a kind of derivatives contract popular with retail traders for its flexibility.

Retail forex trading

Retail traders make up a tiny part of the overall volume in the global forex market. Most currency trading takes place using derivatives, with FX swaps accounting for a majority of daily trading volume. To master this financial market, you need to understand some of the basics.

Basics: what is forex?

To get active in the forex market you need to understand some basic terms. Currencies are quoted in forex pairs. What is a forex pair? A forex pair shows the value of one currency in units of a second currency.

• GBP/USD shows how many US dollars you can buy for one pound Sterling.
• AED/USD shows how many US dollars you can buy for one Emirati dirham.

Bases, quotes, and pips

The first currency in a currency pair – GBP in the above example – is known as the base currency. The second is the quote currency. Currency pairs are quoted to four decimals, and each unit of the fourth decimal is known as a pip. That means a move in EUR/USD from 1.0852 to 1.0853 involves ‘one pip’. You will sometimes hear spreads or prices quoted in terms of pips.

Pegged and free-floating currencies

A key characteristic of the foreign exchange market is that not all currencies trade freely. Many economies peg their national currency to another, usually the US dollar. This is known as a currency peg, and trading activity may be limited to a narrow range of a few pips. Mostly, forex CFD traders are interested in volatile, free-floating currencies, but understanding how national governments control FX reserves is an important detail to remember.

Forex market overview

Learning how to trade forex involves grasping some of the basics of this vast financial market. Whenever you look at a new market, important things to understand include market participants, products, and locations. The foreign exchange market is no exception. Forex is traded over the counter (OTC), instead of on centralised exchanges like the stock market. The market operates 24 hours a day, five days a week. Although any currency can be traded at any time of day, liquidity is concentrated in the market hours of the home market. That means executing trades in certain currencies may be more difficult outside of these hours.

Forex market sessions

The forex trading day is divided into four sessions: Sydney, Tokyo, London and New York. Each session follows the working day of offices in those cities. In UTC hours, they go as follows:

• Sydney: 22:00 – 07:00
• Tokyo: 00:00 – 09:00
• London: 08:00 – 17:00
• New York: 13:00 – 22:00

The highest volume periods fall from around 00:00 to the opening of the Tokyo session, and the overlap between the London and New York sessions. In these periods volume is highest, so the best time to trade forex in the UAE will overlap with one or more of these sessions. The Dubai forex trading day is split between a morning session that overlaps with Tokyo, and an afternoon overlapping with London. Dubai is three hours ahead of London, and five hours behind Tokyo, and if UAE forex traders can hang on until 17:00 or 18:00 local time, they benefit from the high-liquidity London / New York overlap.

Other currency trading hours

Most forex traders deal in their home currency alongside the US dollar, so non-dollar currencies will have liquidity and volume concentrated during working hours for that country. Although these trading windows aren’t as significant as the four major sessions, they may be locally important for specific currency pairs.

Forex market participants

It’s not enough to know what the forex market is and how it works – you need to know who trades in it. Forex volume is dominated by large institutional players, trading FX swaps. Their reasons for interacting with the market are very different to retail and corporate FX traders, and they move the market differently. Learning about forex market participants will help you understand price action and trade better.

National governments and international organisations

Different nations hold FX reserves. They do this to stabilise the market rate of their own currency, maintain liquidity for interest payments and imports, and facilitate trade. Most national governments will hold substantial foreign currency reserves, mostly in the international reserve currencies, such as the US dollar or Japanese yen. These trades will mostly use simple cash purchases or basic derivatives such as swaps, and are distinguished by their enormous size; China, for example, held foreign exchange reserves of almost $3.3 trillion in August 2024.

Financial institutions

Financial institutions such as banks and pension funds have obligations to make payments in multiple national currencies. Like national governments, they may have foreign-denominated debt and hold substantial debt reserves. Banks will normally convert profits into one of the global reserve currencies, and since most international trade takes place in US dollars many companies use their bank as an FX broker to facilitate transactions. Investment banks also offer market making – continuous buying and selling to external clients – in different currencies. Some banks also have prop trading desks that speculate in currency markets to make profit for the bank. Prop traders – short for proprietary trading – use similar methods to retail CFD traders to identify profitable trading opportunities. They are active in both spot and derivative markets.

Retail speculators

Retail speculators are the smallest actors in the global forex market. Active in both spot and derivative markets (such as CFD trading), retail traders use technical and fundamental analysis to identify opportunities. Retail forex traders use leverage to command larger positions than their capital permits, allowing them to profit off small market movements. Of course, any use of leverage magnifies losses as well as gains, so it is important to control position size and place trades carefully.

Trading forex CFDs: steps to getting started

We have looked at how the forex market works, who is involved in it, and what products they trade. But to get active in the forex market you need to follow some simple steps:

1. First, you need to understand some basic information about the FX market. What currencies are you trading, what are the national economies behind them based on, are they pegged or free-floating.
2. Next, you need to open a demo account with ADSS. This will allow you to access charts and live quotes, placing dummy trades in the market without risking any of your capital.
3. Then, you can use your demo trading to develop a live market strategy. Check what works and what doesn’t in demo markets and formulate some rules for how you will trade with real money.

Once you have completed these preliminary steps, you are ready to open and fund a live forex trading account.

Relation to other markets and price action

Forex trading is a great place to get started trading CFDs. The forex market uses many of the same analysis and risk management principles as stock or bond markets. Educating yourself about different types of currency and how they trade is an important part of mastering the forex market.

General market sentiment

Different currencies follow different price trajectories. Safe haven currencies, such as the Swiss franc or US dollar, may perform well during a risk off market environment, when traders rotate out of equities and other high-risk assets. Emerging markets currencies, usually traded as the quote currency in a pair with the US dollar (a pair type known as an exotic pair), are risk on assets. These perform better when financial markets are experiencing lower volatility and strong price performance.

National economic indicator

The value of a currency is negatively influenced by inflation and can be used as a national economic indicator. Countries with stable and prosperous economies may experience FX strength, while volatile states in financial difficulty could see FX weakness against major pairs.

Deliberate policy

Central banks and national governments intervene directly in FX markets. They do this to maintain pegs, boost the value of the currency, and sometimes to deliberately devalue it. Nations with economies geared towards manufacturing exports sometimes benefit from a weak currency, as it makes their products cheaper to buy in US dollar terms.

Forex fundamental analysis

Most retail traders use technical analysis to trade forex, and this is an important part of the overall market. But fundamental analysis shouldn’t be overlooked: FX markets are responsive to news and economic events, which are scheduled in the economic calendar. The economic calendar or trading calendar is a list of market-relevant announcements, showing when they will be announced. Famous examples include the US non-farm payroll and national GDP growth announcements. FX markets respond sharply to these announcements, particularly when they surprise traders with a higher or lower figure than expected. Fundamental factors such as the balance of trade, interest rates, and government spending all influence FX rates. That means you should approach the forex market with at least some understanding of fundamental analysis.

Forex technical price signals

Technical analysis is the most important tool for trading in forex markets. It involves analysing past price movements and identifying trends to predict future price behaviour. You can learn more about technical analysis on the ADSS education section. Forex traders use a variety of technical indicators and chart patterns to make decisions, such as moving averages, trend lines, support and resistance levels, and oscillators like the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD).

Entry and exit points

One of the primary goals of technical analysis is to identify potential entry and exit points for trades. By recognising patterns such as double tops, head and shoulders, or flag patterns, traders can anticipate reversals or continuations of current trends. For example, a breakout from a resistance level might suggest a buying opportunity, while a failure to break above resistance could signal a potential sell-off.

Candlestick patterns

Candlestick patterns are also widely used in forex technical analysis. Patterns like the ‘hammer’, ‘doji star’ or ‘inverted hammer’ can provide clues about market sentiment and potential reversals. Combining multiple indicators and analysing price action allows traders to make informed decisions about when to enter or exit positions.

Risk management in forex

Risk management in forex relies on the same principles as for stocks, shares, or commodities, but it is particularly critical in the forex market due to the widespread use of leverage. Leverage allows traders to control larger positions with a smaller amount of capital, but it also amplifies losses. To protect their capital, traders use various risk management strategies. You can learn more about forex risk management in some of our detailed introductory guides.

Stop-loss orders

Stop-loss orders, often known simply as stop losses, are one of the most common tools in forex risk management. By placing a stop-loss order at a predetermined price level, traders can automatically close their position when the market moves against them beyond a certain point. This prevents small losses from turning into large, account-draining losses.

Position sizing

Position sizing is another important concept in forex risk management. Traders need to calculate the size of their trades based on their account balance and the level of risk they are willing to take. Traders typically do not have one individual trade that takes up too much of their overall portfolio.

Diversification

Diversification is closely related to position sizing and involves spreading your trades over multiple uncorrelated pairs. Instead of putting all their capital into a single currency pair, traders diversify their positions across multiple pairs. This helps to spread the risk and reduce the impact of a single adverse market movement. Diversifying into other asset classes like commodities or indices through CFDs can further enhance risk management, as will diversifying across currency pair types, such as safe haven currencies and emerging markets currencies.

Conclusion

Mastering the forex market isn’t easy, and becoming a competent trader requires a good understanding of market structure, technical analysis, and effective risk management. By learning the fundamentals of forex trading, such as understanding currency pairs, analysing market sessions, and recognizing different types of forex market participants, you can develop a solid foundation. Forex trading is best learned by doing. Opening an ADSS demo account allows you to practice without risking real capital, to understand how price action behaves, and refine your trading skills before moving to a live account. The forex market, with its 24/5 access and high liquidity, offers countless opportunities for those willing to learn and develop their trading approach. Start your journey today by opening a demo account and take your first step into the world of forex trading.