Foreign Exchange Market: A Comprehensive Guide to Understanding Trading and Investment Mechanisms

What is the Foreign Exchange Market

The foreign exchange market is the place where various economic parties—ranging from banks and financial institutions to corporations and individuals—come together to exchange currencies globally. Every time you convert money before a trip or pay for a service in a foreign currency, you are directly participating in this massive, nonstop market.

The forex market is the largest in the world in terms of transaction volume and liquidity. The average daily trading volume reached $9.6 trillion according to the latest statistics in April 2025, vastly surpassing the combined trading volume of global stock markets. This is due to the global nature of currencies and the reliance of the international economy on continuous currency exchanges.

While many use currencies for travel or international trade, specialized traders aim to profit from ongoing exchange rate fluctuations. Forex trading offers opportunities for investment and speculation by buying one currency against selling another, aiming to benefit from price movements. However, despite its opportunities, this market also carries significant risks due to leverage and rapid price volatility.

How Forex Trading Works

The forex market does not operate through a single centralized exchange like stock markets. Instead, trading occurs over a global electronic network of banks and financial institutions communicating electronically, known as over-the-counter (OTC).

Traders always deal with currency pairs such as EUR/USD or USD/JPY. In each pair, the first currency is the “base currency,” while the second is the “quote currency.” The quoted price reflects how much of the quote currency is needed to buy one unit of the base currency.

Trader decisions are based on their expectations:

• Buy means expecting the base currency to appreciate
• Sell means expecting the base currency to depreciate

The market operates continuously via a global network, 24 hours a day, five days a week. Currency movements are influenced by various economic and political factors such as interest rates, economic growth, inflation, and geopolitical stability.

Currency Pair Classifications

Currency pairs are divided into three main groups based on trading volume and liquidity:

Major Pairs (Majors)
Include the most traded currencies worldwide, representing major economies. They feature high liquidity and narrow spreads. They account for the largest share of daily trading. Examples: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, USD/CAD.

Minor Pairs (Minors)
Do not include the US dollar and are also called cross pairs. Less active than majors but still popular, with higher trading costs due to wider spreads. Examples: EUR/GBP, EUR/CHF, GBP/JPY, CAD/JPY, EUR/NZD.

Exotic Pairs (Exotics)
Combine strong currencies with emerging market currencies. They tend to be more volatile with wider spreads, suitable for experienced traders. Examples: USD/MXN, USD/THB, GBP/PLN, EUR/RUB.

Basic Market Terms

Spread (Spread): The difference between the bid and ask price. The smaller, the better for traders. Example: If the bid is 1.1050 and the ask is 1.1048, the spread is 2 pips.

Lot (Lot): A measurement unit that determines the size of a trade. Divided into standard, mini, and micro lots to facilitate risk management and trading volume control.

Pip (Pip): A unit measuring currency price change, usually representing the movement in the fourth decimal place. Example: a move from 1.1000 to 1.1001 is a 1 pip movement.

Leverage (Leverage): A tool that allows increasing the size of a trade using a small amount of capital. It amplifies both potential profits and losses. Example: depositing $100 with 1:100 leverage allows trading with $10,000.

Margin (Margin): A small amount of the trade’s value used as collateral. Includes the initial margin to open a position and the maintenance margin to keep it open. Example: a $1,000 trade might require only $50 margin.

Market Hours and Main Sessions

The market operates almost nonstop, open 24 hours a day, five days a week. Trading begins with the Sydney session in the morning, followed by Tokyo, London, and finally New York in the evening.

Positions are automatically extended at 5:00 PM New York time (rollover), which renews settlement dates. An exception is for NZD pairs, where extension occurs at 7:00 AM Auckland time.

The best trading times are during overlaps of main sessions, especially between London and New York, where trading volume and liquidity increase significantly. Conversely, activity tends to decrease during the Asian session.

Main Factors Affecting Exchange Rates

Central Bank Monetary Policies
Decisions on interest rates directly impact currency value. Raising interest rates makes a currency more attractive to foreign investors. Example: In 2022, the US Federal Reserve raised interest rates consecutively, leading to a stronger dollar against the euro and yen.

Inflation and Economic Growth
High inflation reduces purchasing power, while strong economic growth attracts investments and strengthens the currency. Example: In 2015, China announced a slowdown in growth and devalued the yuan.

Government Intervention
Central banks sometimes intervene directly in the market to support or devalue their currency. This happened during the Plaza Accord in 1985.

Geopolitical Events
Political crises and international tensions drive investors toward “safe-haven” currencies like the dollar and yen. During the COVID-19 pandemic in March 2020, investors flocked to the dollar and yen as safe assets.

Trading Styles: Long-term vs. Short-term

Long-term Trading
Involves holding positions for weeks, months, or even years. Focuses on fundamental analysis and overall trends. Requires less daily monitoring, allowing more time for planning and analysis. Reduces psychological pressure compared to short-term trading. Uses tools like futures contracts on major pairs.

Short-term Trading
Focuses on daily and intraday price movements for quick profits. Positions last from minutes to a few days. Includes strategies like day trading and scalping. Demands continuous monitoring and intensive technical analysis. Benefits from quick market fluctuations. Reduces overnight risk by closing positions daily.

Features and Risks

Main Advantages:

• 24/5 trading provides great flexibility
• Low capital requirements due to leverage and tight spreads
• High liquidity and easy order execution
• Diverse profit opportunities from short- and long-term moves
• Lack of a central exchange reduces price manipulation

Main Risks:

• Potential to lose all capital due to rapid volatility
• Difficult for beginners to learn and apply
• Continuous price swings can lead to significant losses
• Managing trades 24/7 is challenging
• Risks associated with leverage use

Popular Trading Strategies

Scalping (Scalping)
Opening and closing trades within minutes or seconds to achieve small profits. Suitable for exploiting intraday volatility.

Day Trading (Day Trading)
Opening and closing trades within the same day. Targets short-term fluctuations and avoids overnight risks.

Swing Trading (Swing Trading)
Holding positions for days or weeks to capitalize on medium-term trends, offering larger profit opportunities.

Trend Following (Trend Following)
Following the overall price movement, buying in uptrends and selling in downtrends, using moving average indicators.

Basic Technical Indicators

Moving Averages: Help identify overall trend and reduce the impact of daily fluctuations.

Relative Strength Index (RSI): Shows if the price is overbought or oversold.

MACD Indicator: Indicates overall trend and potential reversals.

Bollinger Bands: Reveal expected volatility levels.

Support and Resistance: Specific price levels where the market tends to pause or reverse.

Essential Tips for Beginners

• Study the market and factors influencing currencies before starting
• Set a clear plan with goals and risk levels
• Practice with demo accounts before investing real money
• Manage risks wisely and use stop-loss orders
• Control emotions; don’t let losses or greed dictate decisions
• Keep learning and stay updated with economic news and technical analysis

Summary

The foreign exchange market is the largest in the world in terms of transaction volume. It offers individuals, companies, and banks the opportunity to trade currencies and profit from price changes. Its high liquidity and 24-hour availability provide great flexibility for traders. Entry can be made with small capital via leverage, but it also involves significant risks requiring deep understanding and prudent management. Success in forex trading depends on continuous learning, developing analytical skills, and emotional control. Whether your goal is quick profits or building a long-term investment strategy, proper market understanding and sound planning are the foundation of a successful experience.