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What Is Forex Trading UK & How Does It Work?

Tobi Opeyemi Amure
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What Is Forex Trading & How Does It Work?

In a nutshell, forex trading in the UK involves exchanging one currency for another on the foreign exchange market, to make a profit from currency price fluctuations. Traders can speculate on the rising or falling values of currencies in pairs (e.g., GBP/USD, EUR/GBP), using leverage to increase potential gains or losses. This activity is regulated in the UK by the Financial Conduct Authority (FCA), ensuring fair and ethical trading practices.

Welcome to the world of Forex trading, a global marketplace that never sleeps.

In this article, I’ll delve into the basics of Forex trading, explaining what it is, how it works, and what you need to know to get started.

Whether you’re a seasoned investor looking to diversify your portfolio or a beginner curious about currency trading, this guide aims to provide you with the essential knowledge to navigate the largest financial market in the world.

This article was reviewed by Tobi Opeyemi Amure, a trading expert and writer at InvestopediaInvesting.com, and Trading.biz.

What Is Forex Trading?

Forex trading, also known as foreign exchange trading or currency trading, involves the buying and selling of currencies on the foreign exchange market with the aim of making a profit.

The forex market is the largest financial market in the world, with a daily trading volume exceeding $6 trillion.

Unlike other financial markets like stocks or commodities, the forex market is decentralised, meaning it operates 24 hours a day during weekdays, allowing traders to participate from anywhere in the world at any time.

The primary goal of forex trading is to exchange one currency for another, expecting the price will change in your favor. The price of currencies is always quoted in pairs, such as EUR/USD or GBP/USD.

How Does Forex Trading Work?

Forex trading works by simultaneously buying one currency while selling another, to profit from the fluctuations in exchange rates between the two currencies.

The forex market is decentralised, operating 24/5, and involves a global network of banks, financial institutions, brokers, and individual traders.

Here’s a breakdown of how it works:

Currency Pairs

Currencies are traded in pairs, such as EUR/USD, where the first currency (EUR) is the “base” and the second (USD) is the “quote” currency. The pair indicates how much of the quote currency is needed to purchase one unit of the base currency.

Bid & Ask Price

The “bid” is the price at which you can sell a currency pair, and the “ask” is the price at which you can buy it. The difference between these two prices is known as the “spread.”

Leverage

Forex trading often involves the use of leverage, which allows you to control a large position with a relatively small amount of capital. However, leverage also amplifies both gains and losses.

Trading Platforms

Traders use online platforms provided by brokers to execute trades. These platforms offer various tools for analysis, charting, and risk management.

Market Orders & Limit Orders

A “market order” is an instruction to buy or sell immediately at the current market price. A “limit order,” on the other hand, is an instruction to buy or sell at a specific price or better.

Risk Management

Effective risk management strategies, such as using stop-loss orders, are crucial in forex trading to protect against significant losses.

Profit & Loss

You make a profit if you buy a currency pair and its price rises, or if you sell a currency pair and its price falls. Conversely, you incur a loss if the price movement is against your trade.

Understanding these basic elements and how they interact is crucial for anyone interested in forex trading. It’s also essential to have a well-thought-out trading strategy and to understand the risks involved.

Forex Trading Essentials for Beginners

Here are some forex essentials you need to know.

What Is a Forex Pair?

A forex pair, or currency pair, is the quotation of two different currencies in the foreign exchange market, where one currency is traded against another.

The first currency in the pair is known as the “base currency,” and the second currency is called the “quote currency.”

The forex pair indicates how much of the quote currency is needed to purchase one unit of the base currency. For example, in the currency pair EUR/USD, EUR is the base currency, and USD is the quote currency.

If the EUR/USD pair is quoted at 1.2000, it means that one Euro can be exchanged for 1.2000 US Dollars. Currency pairs are the fundamental building blocks of forex trading, and understanding how they work is crucial for traders looking to profit from currency fluctuations.

The base currency serves as the reference point for the trade, and all profits and losses are calculated in terms of this currency.

The quote currency, on the other hand, represents the value of the base currency in relation to itself.

Understanding the roles of the base and quote currencies is fundamental to forex trading, as it sets the foundation for making informed trading decisions.

Types of Forex Pairs

Forex pairs can be categorised into three main types, each with its own set of characteristics and considerations for traders:

Major Pairs
  1. EUR/USD (Euro/US Dollar)
  2. GBP/USD (British Pound/US Dollar)
  3. USD/JPY (US Dollar/Japanese Yen)
  4. USD/CHF (US Dollar/Swiss Franc)
  5. AUD/USD (Australian Dollar/US Dollar)
  6. USD/CAD (US Dollar/Canadian Dollar)
  7. NZD/USD (New Zealand Dollar/US Dollar)

Major pairs are the most traded currency pairs in the forex market and typically have the lowest spreads. They all include the US Dollar, which is the world’s primary reserve currency.

Minor Pairs
  1. EUR/GBP (Euro/British Pound)
  2. EUR/AUD (Euro/Australian Dollar)
  3. GBP/JPY (British Pound/Japanese Yen)
  4. AUD/JPY (Australian Dollar/Japanese Yen)

Minor pairs do not include the US Dollar but consist of other major currencies. These pairs are less liquid than the major pairs and may have slightly higher spreads.

Exotic Pairs
  1. USD/TRY (US Dollar/Turkish Lira)
  2. EUR/ZAR (Euro/South African Rand)
  3. GBP/TRY (British Pound/Turkish Lira)
  4. USD/SGD (US Dollar/Singapore Dollar)

Exotic pairs consist of one major currency and one currency from a developing or smaller economy. These pairs are less liquid and have higher spreads compared to major and minor pairs.

Understanding the types of forex pairs is crucial for traders as each category offers different levels of liquidity, volatility, and risk.

Major pairs are generally more stable but offer lower returns, while exotic pairs can offer high returns but come with higher risks and costs.

Choose the type of forex pair that aligns with your trading strategy, risk tolerance, and market expertise.

What Is a Pip in Forex?

In forex trading, a “Pip” stands for “Point in Percentage” and is a unit of measurement for the change in value between two currencies.

A pip is typically the smallest price move that can be observed in the exchange rate for a currency pair. For most currency pairs, a pip is usually the fourth decimal place in the price quote.

For example, if the EUR/USD pair moves from 1.1150 to 1.1151, that .0001 USD rise in value represents one pip. In currency pairs that involve the Japanese Yen, like USD/JPY, a pip is usually represented by the second decimal place.

Pips are used to measure price movements in forex trading and to indicate the amount of profit or loss in a trade.

Understanding what a pip is and how it works is crucial for traders who aim to capitalise on small price movements in the market.

See also: What is a pip in forex?

What Is a Lot in Forex Trading?

In forex trading, a “lot” refers to a standardised quantity of a currency pair that traders buy or sell. It’s essentially the unit size of a forex trade. The standard lot size is 100,000 units of the base currency. For example, if you’re trading the EUR/USD pair, a standard lot would be €100,000.

There are also smaller lot sizes like mini lots, which are 10,000 units, and micro-lots, which are 1,000 units of the base currency. Trading in lots helps to standardize the size of trades across the forex market, making it easier for traders to manage risk and calculate potential profits or losses.

The concept of lots is crucial for understanding leverage, as the use of leverage allows traders to control a large position (lot) with a relatively small amount of capital.

What Does It Mean to Buy or Sell a Currency Pair?

Buying or selling a currency pair in forex trading involves speculating on the future direction of the exchange rate between the two currencies. When you buy a currency pair, also known as “going long,” you are betting that the base currency will strengthen against the quote currency.

In this case, you expect the price of the currency pair to rise. For example, if you buy the EUR/USD pair, you are essentially buying Euros while simultaneously selling U.S. Dollars, expecting that the Euro will appreciate in value relative to the Dollar.

Conversely, when you sell a currency pair, or “go short,” you are betting that the base currency will weaken against the quote currency, expecting the price to fall. Selling the EUR/USD pair means you are selling Euros and buying U.S. Dollars, anticipating that the Euro will depreciate against the Dollar.

What Is the Spread in Forex Trading?

In forex trading, the “spread” refers to the difference between the “bid” and “ask” prices of a currency pair. The bid price is the price at which you can sell a currency pair, while the ask price is the price at which you can buy it. The spread is usually measured in pips and represents the broker’s commission for executing the trade.

For example, if the EUR/USD pair has a bid price of 1.1150 and an ask price of 1.1152, the spread would be 2 pips. Spreads can vary based on the currency pair, market conditions, and the broker’s policy.

Some brokers offer fixed spreads, which stay the same regardless of market conditions, while others offer variable spreads that can widen or narrow depending on market volatility.

What Are Margin & Leverage in FX Trading?

In forex trading, “margin” and “leverage” are two closely related concepts that allow traders to control a large position with a relatively small amount of capital.

Margin

Margin is the amount of money that a trader needs to deposit with a broker to open a trading position. It acts as collateral and is expressed as a percentage of the full position size.

For example, if you want to trade a standard lot of EUR/USD (€100,000) with a margin requirement of 1%, you would need to deposit €1,000 into your trading account.

Leverage

Leverage is the ratio that enables traders to control a large position with a small margin. It is usually expressed as a ratio, such as 50:1, 100:1, or 500:1. A 50:1 leverage means that for every $1 in your account, you can control a trade worth $50.

Leverage amplifies both profits and losses, making it a double-edged sword. While it can significantly increase your potential returns, it can also lead to rapid losses, exceeding your initial margin deposit.

Understanding margin and leverage is crucial for forex traders, as both can significantly impact the profitability and risk level of your trades. It’s essential to use leverage cautiously and to be aware of the margin requirements to avoid margin calls or forced liquidation of positions.

See also: What is leverage in forex?

Forex Trading Example

Let’s walk through a simple example to illustrate how forex trading works:

Currency Pair: EUR/USD

Suppose you are interested in trading the EUR/USD currency pair, which is currently quoted at a bid price of 1.1150 and an ask price of 1.1152. The spread is 2 pips.

Going Long (Buying)

You believe that the Euro will strengthen against the U.S. Dollar, so you decide to “go long” and buy one standard lot (€100,000) at the ask price of 1.1152.

Leverage & Margin

Your broker offers a leverage of 50:1, which means you only need to deposit 1/50th of the total position size as margin. For a €100,000 position, you would need to deposit €2,000 (1.1152 x 100,000 / 50) into your trading account.

Price Movement

After a few hours, the EUR/USD pair rises to 1.1172/1.1174. You decide to close your position and sell at the bid price of 1.1172.

Profit Calculation

The price has moved 20 pips in your favor (from 1.1152 to 1.1172). Since you traded one standard lot of €100,000, your profit would be €200 (0.0020 x 100,000).

Closing the Position

To close the position, you sell one standard lot at the bid price of 1.1172. Your profit is locked in, and the margin of €2,000 is released back into your trading account.

This example simplifies many factors such as trading costs, overnight fees, and risk management strategies, but it serves as a basic illustration of how forex trading works.

Why Do People Trade Forex?

People trade forex for various reasons, each with their own unique goals and risk tolerance. Here are some of the primary motivations:

Profit Potential

The forex market offers significant profit potential due to its high liquidity and 24/5 trading hours. Traders can capitalise on price movements in both rising and falling markets.

Leverage

Forex trading allows for the use of leverage, enabling traders to control a large position with a relatively small amount of capital. This amplifies both profits and losses, making it attractive for those looking for higher returns.

Diversification

Investors often include forex trading in their portfolios as a means of diversifying their assets. Forex markets sometimes behave differently from other financial markets, offering opportunities for risk diversification.

Hedging

Companies and investors may also engage in forex trading as a hedge against currency risk. For example, an exporter may sell a foreign currency to hedge against a future payment.

Accessibility

The forex market is accessible to almost anyone with a computer and internet connection. Many online brokers offer user-friendly platforms and a range of educational resources, making it easier for individual traders to participate.

Speculation

Some people are attracted to the challenge and excitement of speculating on currency movements. They may use a variety of trading strategies, from scalping to swing trading, to try and profit from market volatility.

Professional Career

For some, forex trading is not just a hobby but a career. These individuals may work for financial institutions, trade for proprietary trading firms, or become independent full-time traders.

Understanding your reasons for trading forex is crucial as it will guide your trading strategy, risk management, and overall approach to the market.

How Do I Start Trading Forex UK?

Starting to trade forex in the UK involves several key steps, each crucial for setting up a successful trading journey.

Here’s a guide to help you get started:

Education

  1. Learn the Basics: Familiarise yourself with forex trading concepts, terminology, and strategies. Many online resources, courses, and webinars are available for beginners.

Research and Planning

  1. Market Research: Understand the currency pairs you wish to trade, market conditions, and economic indicators that influence forex markets.
  2. Trading Plan: Develop a trading plan outlining your risk tolerance, profit goals, evaluation criteria, and trading strategy.

Choose a Broker

  1. Select a Broker: Choose a reputable forex broker that offers a user-friendly trading platform, low spreads, and strong customer support. Make sure the broker is regulated by a recognised authority like the Financial Conduct Authority (FCA) in the UK.
  2. Open an Account: Complete the registration process, which usually involves providing identification documents for verification.

Demo Trading

  1. Practice with a Demo Account: Most brokers offer demo accounts where you can practice trading with virtual money. Use this to familiarise yourself with the trading platform and test your trading strategy.

Funding and Trading

  1. Fund Your Account: Once you’re comfortable, deposit real money into your trading account using one of the payment methods offered by your broker.
  2. Start Trading: Buy or sell currency pairs based on your analysis and trading plan. Make sure to use risk management tools like stop-loss and take-profit orders.

Monitoring and Review

  1. Monitor Your Performance: Regularly review your trades to identify what you’re doing right and where you can improve.
  2. Continuous Learning: The forex market is dynamic, and continuous learning is essential for long-term success. Keep yourself updated with market news and changes in economic indicators.

Risk Management

  1. Use Risk Management Tools: Always use risk management strategies to minimise potential losses. This includes setting stop-loss orders and only risking a small percentage of your trading capital on a single trade.

See my comprehensive guide on ‘How to trade forex UK‘.

Common Forex Trading Strategies

Forex trading offers a variety of strategies to suit different trading styles and objectives.

Here are some common forex trading strategies:

  1. Scalping: Scalpers aim to profit from small price movements by executing a large number of trades in a short time frame. They target very short-term gains and often use high leverage.
  2. Day Trading: Day traders open and close positions within the same trading day, avoiding overnight exposure. They rely on technical and fundamental analysis for short-term price predictions.
  3. Swing Trading: Swing traders aim to capture price swings or “swings” in the market, holding positions for several days or weeks. They use technical analysis to identify entry and exit points.
  4. Trend Following: Trend followers look for established trends and enter positions in the direction of the trend. They use various technical indicators to confirm trends and stay in positions for extended periods.
  5. Counter-Trend Trading: Counter-trend traders seek to profit from market reversals or corrections against the prevailing trend. They often use indicators like oscillators to identify potential reversals.
  6. Range Trading: Range traders focus on currency pairs that are trading within a defined range or sideways movement. They buy at support levels and sell at resistance levels.
  7. Carry Trade: Carry traders take advantage of interest rate differentials between two currencies. They borrow funds in a currency with a low interest rate and invest in a currency with a higher interest rate, earning the interest rate differential as profit.
  8. Breakout Trading: Breakout traders look for price levels where a currency pair breaks out of its established range. They enter positions when the price breaks above resistance or below support.
  9. Hedging: Hedging involves opening positions in the forex market to offset potential losses in another market or investment. It’s a risk management strategy.
  10. News Trading: News traders react to economic events and news releases that can cause significant market volatility. They aim to profit from rapid price movements immediately following news announcements.
  11. Algorithmic Trading: Algorithmic traders use automated trading systems and algorithms to execute trades based on predefined criteria. These systems can analyze large amounts of data and execute trades at high speeds.

See my comprehensive guide on the ‘Best forex trading strategies‘.

Is Forex Trading a Good Idea?

The question of whether forex trading is a “good idea” depends on various factors, including your financial goals, risk tolerance, and level of expertise. Forex trading offers the potential for significant profits due to its high liquidity and 24/5 market hours, but it also comes with substantial risks.

The use of leverage can amplify both gains and losses, making it possible to lose more than your initial investment. It’s a market that requires a deep understanding of economic indicators, geopolitical events, and market psychology.

For those willing to invest time in education, develop a robust trading plan, and practice disciplined risk management, forex trading can be a rewarding endeavor. However, it’s not suitable for everyone and should only be undertaken with money you can afford to lose.

If you’re new to trading, starting with a demo account to practice without financial risk is highly advisable.

Is Forex Trading Profitable?

Forex trading can be profitable, but it’s important to note that it comes with high risks and is not suitable for everyone. The market is highly volatile and leveraged, meaning that small price movements can result in significant profits or losses.

According to various studies, a large percentage of retail forex traders lose money, often because they lack a well-thought-out trading strategy, discipline, or proper risk management. However, those who approach forex trading as a business, rather than a form of gambling, have a better chance of achieving profitability.

This involves continuous education, careful planning, backtesting strategies, and maintaining a trading journal for performance review. Even then, there are no guarantees of profit, and traders should only invest money they can afford to lose.

Is £100 Enough to Start Forex?

Starting with £100 in forex trading is possible, but it comes with limitations and increased risks. With such a small amount, you’ll likely be trading micro or mini lots, which means each pip movement will represent a smaller profit or loss.

While some brokers offer high leverage to enable trading larger positions with a small deposit, using high leverage can amplify both gains and losses, potentially wiping out your account quickly. Trading with £100 also limits your ability to diversify and properly manage risk, as you won’t have much room for error.

If you’re a beginner, it might be a good idea to start with a demo account first to practice without financial risk. Once you’re comfortable, you can start live trading with £100 as a learning experience, but be prepared for the limitations and risks involved.

Yes, forex trading is legal in the United Kingdom and is regulated by the Financial Conduct Authority (FCA). The FCA is one of the most respected regulatory bodies in the world and provides strong protection for traders.

Forex brokers operating in the UK are required to adhere to strict standards, including capital adequacy requirements, transparent pricing, and fair treatment of customers. They are also required to keep client funds in segregated accounts, separate from the broker’s operating funds, to protect traders in the event of broker insolvency.

Additionally, traders have access to the Financial Services Compensation Scheme (FSCS), which offers compensation in case a regulated broker goes bankrupt. However, while forex trading is legal and regulated, it is also risky and not suitable for everyone.

Traders should only engage with FCA-regulated brokers and should be aware of the risks involved in forex trading.

What Moves the Forex Market?

The forex market is influenced by a variety of factors that drive currency values up or down.

Here are some of the key elements that move the forex market:

Economic Indicators

  1. Gross Domestic Product (GDP)
  2. Employment Data
  3. Inflation Rates
  4. Interest Rates
  5. Trade Balance

Economic indicators provide insights into the health of an economy and often lead to fluctuations in currency value. For example, an interest rate hike usually strengthens a country’s currency.

Political Events

  1. Elections
  2. Political Instability
  3. Policy Changes

Political events can create uncertainty and may lead to volatility in the currency markets. For instance, unexpected election outcomes can result in significant currency movements.

Market Sentiment

  1. Investor Confidence
  2. Risk Appetite
  3. Speculation

Market sentiment can be influenced by news, reports, and other media. Positive sentiment often strengthens a currency, while negative sentiment can weaken it.

Geopolitical Events

  1. Wars
  2. Natural Disasters
  3. Terrorist Attacks

Geopolitical events can lead to uncertainty and may cause significant volatility in the forex market.

Central Bank Actions

  1. Monetary Policy
  2. Currency Interventions

Central banks play a crucial role in the forex market. Their monetary policies and interventions can significantly impact currency values.

Trade Relations

  1. Trade Agreements
  2. Tariffs and Trade Wars

Trade relations between countries can also influence currency strength. A favorable trade balance usually strengthens a country’s currency.

Understanding what moves the forex market is crucial for traders as it helps them to make informed decisions, manage risks, and develop effective trading strategies.

Pros & Cons of Forex Trading

Forex trading offers a range of advantages and disadvantages that traders should consider before diving into the markets.

Here’s a breakdown:

Pros

  1. High Liquidity: The forex market is one of the most liquid markets in the world, allowing for quick entry and exit of trades.
  2. 24/5 Market: Forex trading is available 24 hours a day, five days a week, providing flexibility to trade at any time.
  3. Low Costs: Many brokers offer low spreads and no commissions, making it relatively cheap to trade forex.
  4. Leverage: Traders have the option to use leverage, which can amplify profits. However, it’s a double-edged sword that can also amplify losses.
  5. Accessibility: The forex market is accessible to retail traders, requiring only a small initial deposit to start trading in some cases.
  6. Diverse Trading Opportunities: With a wide range of currency pairs to trade, forex offers opportunities to profit in both rising and falling markets.
  7. Risk Management: Advanced trading platforms offer various risk management tools, like stop-loss orders, to help protect your capital.

Cons

  1. High Risk: Forex trading involves significant risk and it’s possible to lose more money than you initially invested.
  2. Leverage Risks: While leverage can amplify profits, it can also increase losses and may lead to a margin call if you’re not careful.
  3. Complexity: Forex trading is influenced by multiple factors like economic indicators, interest rates, and geopolitical events, making it complex to predict price movements.
  4. Emotional Stress: The high volatility and rapid price movements can be stressful, requiring a disciplined mindset to stick to your trading plan.
  5. Scams and Unregulated Brokers: The forex market is decentralised, making it susceptible to scams and unregulated brokers. Always choose a reputable, regulated broker.
  6. Overnight Risks: Holding positions overnight can expose you to unexpected price movements due to events that occur when the market is closed.

Is Forex Trading Good for Beginners?

Forex trading can be both exciting and educational for beginners, but it also comes with significant risks that should not be overlooked.

On the positive side, the forex market is highly accessible, requiring only a small initial deposit to start trading. Many brokers offer demo accounts, educational resources, and trading platforms that are relatively easy to use. This allows beginners to practice without financial risk and gain valuable trading experience.

However, the forex market is complex and influenced by numerous factors, including economic indicators, geopolitical events, and market sentiment. Beginners may find it challenging to navigate these complexities and are at risk of making costly mistakes.

The use of leverage, while potentially profitable, can also amplify losses, making it possible to lose more than the initial investment. Therefore, proper education, a well-thought-out trading plan, and strict risk management are crucial for beginners.

If you’re new to trading, it’s advisable to start with a demo account and invest time in learning before risking real money.

Forex Trading Basics – Final Thoughts

In conclusion, forex trading offers a world of opportunities but also comes with its own set of challenges and risks.

From high liquidity and 24/5 market access to the complexities of economic indicators and the double-edged sword of leverage, the forex market is a dynamic environment that requires a well-thought-out approach.

For beginners, it’s crucial to start with proper education, practice on a demo account, and develop a robust trading plan.

Understanding both the pros and cons of forex trading can help you make an informed decision about whether this type of trading aligns with your financial goals and risk tolerance.

Remember, the key to long-term success in forex trading lies in continuous learning, disciplined risk management, and emotional resilience.

FAQs

What is a forex broker?

A forex broker acts as an intermediary between retail traders and the interbank forex market. They provide a trading platform where traders can buy and sell currencies, and they make money through spreads and commissions. Choosing a reputable, regulated forex broker is crucial for trading success and security of funds.

What are the forex trading hours?

The forex market operates 24 hours a day, five days a week, due to its global nature and different time zones. The trading week starts in Asia and progresses through Europe and North America. Key trading sessions include the Asian session, European session, and North American session. The overlap between these sessions, especially the European and North American overlap, tends to see higher volatility and trading activity. Traders need to be aware of these hours and choose the most suitable time to trade based on their strategies and currency pairs of interest.

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Will Fenton is the founder of Sterling Savvy. He is a personal finance expert and writes about trading, investing, budgeting, and other financial topics.

Along with his education in Economics & Finance, he has experience working in the financial services industry in London working for one of the UK’s leading financial companies, “a trustworthy and respected provider of news, education and market analysis for the everyday investor”.

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