Three points to keep
- A currency pair is a price for one currency in terms of another; buying the pair means buying the first and selling the second.
- Moves are small, so positions are large and usually leveraged; pip value, not price, is what turns a move into money.
- Retail leverage is capped in the UK, EU, Australia and US, and overnight positions pay or receive financing every evening.
How forex trading works is easiest to grasp if you start with a single quote and follow it all the way to your account balance. The market itself is simple in outline: currencies are priced against one another, prices move continuously on weekdays, and traders try to profit from the changes. The details, such as pip value, lot size, leverage and rollover, are where most avoidable losses begin, so this guide concentrates on them.
Reading a currency quote
A quote such as GBP/USD 1.2700 says that one pound costs 1.2700 US dollars. The first currency is the base, the second the quote currency. If you buy GBP/USD you are buying pounds and paying in dollars; you gain if the pound strengthens against the dollar. Selling the pair is the opposite position.
A platform shows two prices. The lower one, the bid, is what you can sell at; the higher one, the ask, is what you can buy at. The gap between them is the spread, and it is the first cost of every trade. On major pairs during busy hours it is often a fraction of a pip; on exotic pairs or during news it can widen sharply.
Majors, crosses and exotics
- Majors pair the US dollar with another heavily traded currency: EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD, NZD/USD.
- Crosses leave the dollar out, such as EUR/GBP or AUD/JPY.
- Exotics pair a major currency with one from a smaller or emerging economy. Spreads are wider and moves can be abrupt.
Pips, lots and what a move is worth
For most pairs a pip is the fourth decimal place, 0.0001. For pairs quoted in Japanese yen it is the second decimal, 0.01. Platforms often show a fifth digit (a "pipette"), which is a tenth of a pip.
Positions are sized in lots. One standard lot is 100,000 units of the base currency; a mini lot is 10,000 and a micro lot 1,000. For any pair where the US dollar is the quote currency, a pip on one standard lot is worth $10.
Pip value in USD = that amount ÷ the USD rate of the quote currency, when the quote currency is not USD
Two illustrative cases, using round prices:
- 0.5 lots of GBP/USD: 50,000 × 0.0001 = $5 per pip.
- 1 lot of USD/JPY at 150.00: 100,000 × 0.01 = ¥1,000 per pip, which is ¥1,000 ÷ 150 = about $6.67.
The pip calculator handles crosses and gold as well.
How forex trading works with leverage
Because currencies usually move less than 1% in a day, retail forex is almost always traded on margin. You put up a fraction of the position's value as collateral and the provider lets you control the full amount. The ratio is the leverage.
Regulators cap it for retail clients. In the UK and EU the limit is 30:1 on major pairs and 20:1 on other pairs, gold and major indices; Australia applies similar caps; in the US the limit is 50:1 on majors and 20:1 on others. The UK and EU also require providers to close positions when your margin level falls to 50% of the requirement, and to prevent a retail account from going below zero.
A worked example (illustrative numbers)
Suppose you buy 0.5 lots of GBP/USD at 1.2700 with a stop-loss at 1.2660 and a target at 1.2780.
- Position value: 50,000 × 1.2700 = $63,500.
- Margin at 30:1: $63,500 ÷ 30 = about $2,116.67.
- Pip value: $5. Stop distance: 40 pips, so the planned loss is 40 × $5 = $200 plus costs.
- Target distance: 80 pips, so the planned gain is 80 × $5 = $400 before costs.
Notice that the $2,116.67 margin is not the amount at risk. The risk is set by the stop distance and position size, and if the stop is skipped over in a fast market, the loss can exceed $200. The lot size calculator starts from the loss you accept and works out the position that fits.
Rollover: the cost of holding overnight
At 17:00 New York time each weekday, open positions are rolled to the next value date. Because you are effectively borrowing one currency and holding another, the provider charges or credits a swap based on the interest-rate difference between the two, plus its own mark-up. On most platforms the Wednesday rollover is charged three times to cover the weekend settlement days.
For short trades the swap is noise. For positions held for weeks it can decide whether the trade was profitable. Look up swap rates in the provider's contract specifications before holding anything overnight, and see hidden trading costs for how to add them up.
Sessions and liquidity
The market opens on Sunday at 17:00 New York time and runs continuously until Friday at 17:00. Activity follows the business day around the world: the Sydney and Tokyo hours, then London, then New York. Liquidity and volume are usually greatest while London and New York overlap, and spreads tend to be tightest then. Just after the daily rollover, spreads often widen for a few minutes because liquidity is thin.
Scheduled economic releases, such as inflation figures, employment reports and central bank rate decisions, can move a pair by more than a normal day's range in seconds. Stops placed near the price before a release are more likely to fill at a worse level.
What drives exchange rates
- Interest-rate expectations. A currency whose central bank is expected to keep rates higher for longer tends to attract capital.
- Growth and inflation data. Releases that change rate expectations move currencies more than releases that only confirm them.
- Risk appetite. In market stress, money often moves towards the US dollar, yen and Swiss franc.
- Trade and capital flows. Commodity exporters' currencies often track the prices of what they sell.
Forex as trading versus fx investment
Holding foreign currency for the long term, for example as savings in a currency you expect to need, is a different activity from leveraged short-term speculation on pairs. An fx investment in that sense usually means cash deposits, money-market funds or bonds in another currency, where the return comes from interest and the exchange rate. Leveraged CFD trading has no ownership of the currency at all. Know which one a product is before you use it, because the risks and protections are different. Financial markets explained compares the structures.
Mistakes that recur at the next level
- Sizing by margin instead of by stop. The margin figure tells you what is locked up, not what you can lose.
- Ignoring correlation. Long EUR/USD and long GBP/USD are, much of the time, two versions of the same bet against the dollar.
- Holding through rollover without checking the swap, especially over a Wednesday.
- Tight stops before scheduled data, where spreads widen and prices jump.
- Treating a demo record as proof. Live fills and live nerves are different.
Practising before you commit money
A demo account lets you practise order entry, stop placement and position sizing with virtual funds. It cannot show you how you behave when losses are real, and demo fills are often cleaner than live ones. Treat it as a way to learn the platform, not as proof that a strategy works. Our guide to the forex demo contest format explains why leaderboards can teach the wrong habits.
Reader questions
How much money do I need to start trading forex?
Providers set their own minimums, and micro lots make small positions possible. The more useful question is how much you can lose without harm, because position size should follow from that figure, not from the deposit minimum.
Why do forex brokers show different prices?
There is no single central exchange. Each provider takes prices from its own liquidity sources or makes its own quotes and adds its spread, so small differences between platforms are normal.
Is the swap always a cost?
No. Depending on the interest-rate difference between the two currencies and the provider's mark-up, holding a position overnight can be charged or credited. After the mark-up, many positions pay a net charge in both directions.
Sources
- UK Financial Conduct Authority, CFD leverage limits and margin close-out rules
- European Securities and Markets Authority, CFD product intervention measures
- US Commodity Futures Trading Commission and National Futures Association, retail forex leverage limits
- Australian Securities and Investments Commission, CFD product intervention order