What is forex and how does it work?

Forex, short for foreign exchange and also called FX, is the market where one currency is exchanged for another. Banks, companies, governments, investment funds and travellers all use it: a company paying a supplier abroad and a tourist changing money at the airport are both taking part.

There is no single exchange building. Forex is an over-the-counter market: prices are agreed electronically between banks, brokers and other participants around the world. That is why it can stay open around the clock on weekdays, as trading moves from one financial centre to the next.

Most individual traders do not exchange physical currency. They open positions on the price of a currency pair through a broker, often with contracts for difference (CFDs), to gain or lose from the change in the exchange rate.

Currencies are always priced against each other, so they are quoted in pairs. In EUR/USD, the euro is the base currency and the US dollar is the quote currency. A price of 1.1000 means one euro costs 1.1000 US dollars.

If EUR/USD rises, the euro has strengthened against the dollar; if it falls, the euro has weakened. Every quote has two prices: the bid, at which you can sell, and the ask, at which you can buy. The gap between them is the spread, one of the costs of trading.

Major pairs are usually the most traded and tend to have narrower spreads. Exotic pairs are often less liquid, so their spreads are usually wider and their prices can jump further in a short time.

An exchange rate moves when supply and demand for one currency change relative to the other. Many things can shift that balance, and they often act at the same time:

• Interest rate decisions and statements by central banks.
• Economic data such as inflation, employment and growth figures.
• Political events, elections and changes in government policy.
• Trade flows, such as a country's exports and imports.
• General market mood, when investors move money towards or away from risk.

Prices react to news in ways that are hard to anticipate. The same kind of announcement can move a pair one way on one day and the other way on another, and around major releases prices can move sharply while spreads widen. Nobody can reliably know which way a pair will move next.

A pip is the unit used to measure price changes. For most pairs it is the fourth decimal place: EUR/USD moving from 1.1000 to 1.1001 is a one-pip move. For pairs quoted in Japanese yen it is the second decimal place.

Position size is measured in lots. A standard lot is 100,000 units of the base currency, a mini lot is 10,000 units and a micro lot is 1,000 units. The bigger the position, the more each pip is worth.

You buy a pair (go long) to open a position that gains if the price rises, or sell it (go short) to open a position that gains if the price falls. If the price moves the other way, the position loses. The result is the price difference between opening and closing, multiplied by the position size.

Costs come on top of that result: the spread, a commission on some account types, and a swap, an overnight charge or credit for positions held from one day to the next. A trade has to cover its costs before it shows a gain.

Forex positions are usually opened with leverage: you put up a margin, a fraction of the position's value, and the broker holds the rest. NextTrade offers leverage of up to 1:1000, and the maximum depends on the instrument. The leverage guide explains how margin is calculated.

Forex trades from Monday to Friday, around the clock. The day is usually described in four sessions named after financial centres: Sydney, Tokyo, London and New York. Activity tends to be highest when two sessions overlap, and lower late in the day and before the weekend.

The market closes at the weekend. When it reopens, the first price can be different from Friday's last price, a jump known as a gap. A gap can move an open position a long way at once, past the level of a stop loss order. Trading hours for each instrument are shown in the trading platform.