Forex, often shortened to FX, is the global market where currencies are traded as pairs. Each price is an exchange rate that tells you how much of one currency you need to buy one unit of another.
Unlike a stock exchange, most forex trading takes place over the counter. Banks, brokers and electronic venues quote prices to each other and to clients around the clock on weekdays, linking the Asian, European and US sessions.
How currency pairs and quotes work
Currencies trade in pairs because you are always exchanging one for another. The first currency is the base, the second is the quote. If EUR/USD is 1.1000, one euro costs 1.10 US dollars. If the rate rises to 1.1050, the euro has strengthened against the dollar.
Prices are shown with two numbers: bid and ask. The bid is what you can sell the base currency for. The ask is what you would pay to buy it. The difference is the spread, which is one part of your trading cost along with any commission or overnight financing. A pip is the standard unit for small changes, usually 0.0001 for most pairs and 0.01 for yen pairs. Many venues also show a fractional pip, often called a pipette.
Pairs are often grouped as majors, minors and exotics. Majors include the most traded currencies such as EUR/USD, USD/JPY and GBP/USD. Minors omit the US dollar, for example EUR/GBP. Exotics combine a major with a smaller or emerging market currency, which can mean wider spreads and larger swings.
Spot, forwards and futures in forex
Spot forex is the most common form. It is an agreement to exchange currencies at the quoted rate with standard settlement a few business days later. Most retail platforms show a rolling spot price. If you keep a position overnight, the platform will apply a rollover or swap that reflects the interest rate difference between the two currencies.
A forward contract sets an exchange rate today for a currency exchange on a future date. The forward rate is linked to the spot rate and the interest rate gap between the two currencies over the period. Businesses use forwards to lock in costs or revenues and reduce uncertainty. Forwards are negotiated over the counter, so terms can be tailored, but credit arrangements are needed.
Futures are standardised contracts traded on exchanges to buy or sell a currency at a set rate on a set date. They use initial margin and daily variation margin through a clearing house, which reduces counterparty risk. The price behaviour is closely tied to spot and forwards through the same interest differential logic. Read more in our primer on currency futures.
What moves exchange rates
In most countries a floating exchange rate means the market sets the currency’s value based on supply and demand. Several forces feed into that balance:
- Interest rates and expectations for central bank policy. Higher expected rates tend to support a currency because they raise the return on cash and bonds in that currency.
- Inflation trends. High and rising inflation can weaken a currency if it erodes purchasing power and prompts capital to seek stability elsewhere.
- Growth and labour data, trade balances and fiscal policy. Stronger prospects can attract investment, while twin deficits can pressure a currency.
- Risk sentiment. In stress episodes, money often moves into perceived safe havens and out of higher risk currencies.
- Commodity prices for exporters and importers. For example, a country reliant on oil exports can see its currency move with energy prices.
Policy actions and guidance from central banks matter because they shape rate expectations. For the US, traders watch the Federal Reserve. For the eurozone, the European Central Bank. Similar logic applies across other economies.
Who trades forex and why
Forex serves many purposes beyond speculation:
- Corporates hedge future payments and receipts to stabilise budgets. An importer that must pay in dollars may buy USD forward to protect against a rise in the dollar.
- Asset managers and funds adjust currency exposure when buying foreign securities or running global portfolios.
- Banks and market makers quote two way prices to clients and manage their risk across books.
- Central banks transact to implement policy or manage reserves in support of monetary objectives.
- Retail traders speculate on moves in major pairs or run strategies like trend following and carry.
The market’s breadth means liquidity is usually deep in major pairs, with tighter spreads and smaller price gaps. Liquidity can thin during regional holidays, around data releases or in off peak hours between sessions, which can widen spreads and increase slippage.
Costs, leverage and rollover
Trading costs in forex show up as the spread, any commission your provider charges and financing. Providers may offer leverage, which lets you control a larger notional position with a smaller deposit called margin. Leverage amplifies gains and losses, so risk control is essential. Limits, margin rates and protections vary by jurisdiction and provider.
If you hold a spot position past the market’s value date, it is rolled forward by one day and a small financing adjustment is applied. This is the rollover or swap, and it reflects the interest rate difference between the two currencies. If you are long the higher yielding currency against the lower yielding one, you may receive a small positive adjustment. If you are long the lower yielding side, you may pay it. The same rate gap explains why forwards and futures prices differ from spot.
Be aware that providers can change spreads and financing around major news or reduced liquidity. Exact calculation methods differ. Check your platform’s contract specifications and terms.
Example: a simple EUR/USD hedge
Imagine a UK firm will receive 1 million euros in three months from an overseas customer. Today, EUR/GBP is trading at 0.8600 in the spot market. The firm worries the euro might weaken, cutting the pound value of that receivable.
They agree a three month euro forward to sell 1 million euros at a set EUR/GBP rate. The forward rate is based on today’s spot and the interest rate difference between sterling and the euro over three months. If, when the invoice is paid, EUR/GBP has fallen to 0.8350, the firm’s underlying euro asset is worth fewer pounds, but the forward delivers a gain that offsets much of that drop. If the euro instead strengthens, the forward will show a loss that is offset by a higher pound value for the invoice.
Speculative traders use similar mechanics without the underlying cash flow. Suppose a trader believes EUR/USD will rise from 1.1000 and buys one standard lot of EUR/USD, which is often 100,000 euros notional on many platforms. A move to 1.1010 is 10 pips. At 10 dollars per pip for a standard lot in this pair, the unrealised gain is about 100 dollars before costs. If price drops 20 pips instead, the loss is about 200 dollars. Contract sizes and pip values can differ by provider, so always check the ticket details.
Where forex meets the rest of finance
Most forex trading involves government issued money known as fiat currency. FX also intersects with other markets. Equity and bond investors running global portfolios face currency swings that can overshadow the performance of the underlying assets. Commodities priced in dollars can be affected by dollar strength or weakness. Derivatives on currencies sit alongside options, swaps and forwards used for hedging and structured exposures.
In practice, you will encounter forex prices on multi asset platforms, bank portals and data feeds. Execution quality depends on liquidity, the venue’s routing and how your order interacts with the market. Market orders prioritise speed and can slip in fast moves. Limit orders set your worst acceptable price but may not fill. For larger tickets, firms often work orders over time or use algos to reduce market impact.
At its core, forex is about exchanging the value of one economy for another. Understand the pair you are trading, the costs, the interest rate linkages and the times of day liquidity is deepest. Do that, and the price on your screen starts to tell a much clearer story.