TradingKey - In April 2025, the forex market faced significant volatility due to fluctuating tariffs on electronics by the Trump administration, leading the U.S. dollar index to drop below 100 points and causing sharp exchange rate fluctuations.

So, what is forex?

Simply put, forex refers to foreign currencies or payment instruments used for international transactions. When discussing forex, we focus on the exchange rates between different countries' currencies.

For example, when a Japanese company exports goods to the U.S., the dollar payments it receives are classified as forex. Similarly, when a Chinese tourist exchanges yuan for yen while spending in Japan, that transaction also involves forex trading.

The forex market is the platform for buying and selling foreign currencies on an international scale, facilitating the balancing of currency supply and demand.

Its core functions include:

Value Conversion

The forex market enables the conversion of one country's currency (e.g., British pounds) into another (e.g., U.S. dollars) exchange rates are determined in real-time (e.g., 1.2 USD/GBP).

This function supports international trade settlements, such as payments for goods imported by UK businesses from the U.S., and capital allocation in global investments.

Risk Hedging

Businesses and investors utilize instruments like forward contracts and options to manage exchange rate volatility. For instance, exporters can secure a euro-to-dollar exchange rate to mitigate potential losses from currency depreciation when collecting payments.

Massive Scale

The forex market is the largest financial market globally, with a daily trading volume exceeding $6 trillion (according to 2023 BIS statistics), which is over 20 times that of global stock markets. This vast scale provides ample depth and liquidity, ensuring that even large transactions have minimal impact on exchange rates.

24-Hour Continuous Trading

By capitalizing on the time zone differences among global financial centers, the forex market enables round-the-clock trading. Investors can engage in transactions at any time, allowing for flexible participation based on their schedules and market conditions—ensuring they never miss investment opportunities.

High Liquidity and Diverse Participants

The foreign exchange market involves a wide range of participants such as interbank traders, multinational companies, hedge funds, central banks, and sovereign wealth funds. This diversity helps maintain narrow spreads for major currency pairs (like USD/JPY), typically ranging from 1 to 3 pips (0.01% - 0.03%). Even under extreme conditions, liquidity can be swiftly restored through quotes from market makers.

Spot Trading

Spot trading is the most fundamental method of forex trading, involving the actual delivery of currencies on the trade date or within two business days.

Key Features:

Price Transparency: Provides real-time quotes that reflect market supply and demand.

Physical Delivery: Buyers and sellers exchange currencies directly (e.g., a company converts $1 million into €910,000 at the spot rate for import payments).

Low or No Leverage: Primarily caters to genuine trade and capital flow requirements.

Futures Trading

Futures trading involves standardized contracts executed on futures exchanges, where parties agree to buy or sell a specified amount of currency at an agreed-upon exchange rate on a future date.

Key Features:

Standardized Contracts: These contracts define currency pairs, contract sizes, and maturity dates.

Margin Requirements: Typically, a margin of 5% to 10% of the contract value is required.

Bidirectional Strategies: Allows for both long (anticipating appreciation) and short (anticipating depreciation) positions, making it suitable for hedging against exchange rate risks.

Options Trading

Forex options trading provides the option buyer with the right, but not the obligation, to buy or sell a specified amount of currency at an agreed-upon price within a future timeframe.

Core Types:

Call Option: This provides the buyer with the right to purchase currency at a specified strike price (for example, paying a premium of $100 for the right to buy €10,000 at an exchange rate of 1.10).

Put Option: Gives the buyer the right to sell currency at the strike price (e.g., paying an $80 premium for the right to sell ¥100,000 at a rate of 135).

Unique Advantages:

Limited Risk: The maximum loss is confined to the premium paid, while potential gains can be unlimited as exchange rates fluctuate.

Flexible Trading: This trading method offers investors greater flexibility in deciding whether to exercise their options based on anticipated exchange rate movements.

CFD Trading (Contracts for Difference)

CFDs (Contracts for Difference) are financial derivatives that enable investors to speculate on fluctuations in currency pair prices without holding the actual currencies.

Leverage Effect: CFDs enable leveraged trading, allowing investors to control larger positions with smaller amounts of capital, which amplifies both potential profits and risks.

Bidirectional Trading: Investors can profit by taking long (buying) or short (selling) positions.

No Expiry Date: Positions can be maintained indefinitely with only overnight interest costs applicable.

Comparison of Trading Methods and Selection Suggestions

Currency Pair

In forex trading, a currency pair serves as the fundamental unit of trade. It consists of two distinct currencies, such as Euro/US Dollar (EUR/USD), British Pound/US Dollar (GBP/USD), and US Dollar/Japanese Yen (USD/JPY). Within a currency pair, the first currency is referred to as the base currency, while the second is known as the quote currency. Taking the Euro/US Dollar (EUR/USD) pair as an example; here, the euro serves as the base currency and the dollar functions as the quote currency. The exchange rate specifies how many units of the quote currency (USD) are required to acquire one unit of the base currency (EUR). Therefore, if the EUR/USD exchange rate stands at 1.1000, this means 1 euro can be traded for 1.1000 dollars.

Spread

The spread is an essential concept in forex trading that indicates the difference between a currency pair's buying and selling prices. On forex trading platforms, you will encounter a bid price and an ask price; typically, the ask price exceeds the bid price, with their difference defining the spread.

For example, if the bid price for EUR/USD is 1.0990 and the ask price is 1.1000, then the spread amounts to 10 pips (0.0010).

The spread essentially signifies the trading cost. In forex trading, investors can profit only if the currency pair's price movement exceeds the spread. Spreads can fluctuate depending on currency pairs and trading platforms; major pairs often experience smaller spreads due to higher market liquidity and robust trading activity. In contrast, cross-currency pairs or those from emerging markets may exhibit larger spreads.

Leverage and Margin

Leverage is a powerful tool in forex trading. This mechanism allows investors to manage large trades with relatively small capital outlays. Leverage is typically expressed as a ratio, such as 1:100, 1:200, or 1:500. At a 1:100 leverage ratio, an investor requires only $1 of their funds to control a $100-worth trade. While leverage can amplify returns, it simultaneously heightens risks. If the market moves against the investor, losses will be magnified by the leverage ratio.

Margin is the collateral an investor deposits to open and maintain a leveraged trade. The margin amount is based on the trade's contract value and leverage ratio.

Long and Short Positions

A long position, commonly referred to as going long, occurs when an investor anticipates that the value of a currency will increase and subsequently buys that currency pair (e.g., going long on USD/JPY means buying dollars while selling yen). The investor hopes to sell the currency pair at a higher price in the future for profit.

A short position, often referred to as going short, arises when an investor expects that the value of a currency will decline and therefore sells that currency pair. In this scenario, investors borrow the currency pair from their broker without actually holding it initially; they sell it first and plan to buy it back later at a lower price to return it. This difference in prices results in profit for them.

Stop Loss and Take Profit

Stop loss and take profit are critical tools in forex trading for managing risk and securing profits.

A stop loss is an established price point designed to limit potential losses. If the market moves unfavorably and the price reaches or exceeds this level, the trading system automatically closes the position, thereby preventing further losses.

On the other hand, a take profit is used to lock in profits at a specified target. When the market price moves in favor of the investor and hits or exceeds this target, the trading system automatically closes the position to realize those gains. Properly setting take profit levels allows investors to secure profits promptly while avoiding potential reversals that could diminish their earnings.

Pip

A pip represents the smallest incremental change in price within foreign exchange markets; for most pairs, one pip is equivalent to 0.0001. However, for yen-based currency pairs, one pip usually equals 0.01. When trading in a standard lot (which consists of 100,000 units of base currency), each pip typically holds a value of  $10. For instance, if an investor acquires one standard lot of EUR/USD and experiences an increase in price of 10 pips, this results in a profit of 100 (calculated as 10 pips multiplied by $10 per pip).

Understanding the concept and calculation of pips helps investors measure trading profits and risks more accurately.

Slippage

Slippage refers to the discrepancy between the expected price and the actual execution price after an investor places an order. It often occurs during extreme market conditions (such as the release of non-farm payroll data) or periods of low liquidity. For instance, if an investor intends to buy EUR/USD at 1.1000 but ends up executing at 1.1005, the slippage is 0.0005, which increases the overall cost.

Swap

A swap refers to the interest payments that may occur when an investor holds a position overnight (i.e., maintains a position beyond the daily trading session) in forex trading.

Interest Received: When buying a high-yield currency and selling a low-yield currency (e.g., going long on AUD/JPY), investors may earn interest.

Interest Paid: Conversely, performing the opposite transaction will result in interest payments.

Typically, swaps are calculated once daily from Monday to Friday. However, since the market is closed on weekends, Wednesday's swap is usually tripled to cover interest for the two days that positions are held over the weekend.