From Robin Lofton,
Your Guide to Forex Trading.
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Trading Forex

Trading Forex is the simultaneous purchase and sale of two currencies. Unlike stocks or commodities, currencies cannot be traded individually. Currencies are traded in pairs called a “currency pair.”

An example of a currency pair is the USD/CAD. This currency pair refers to the US dollar as the base currency and the Canadian Dollar as the quote (or secondary) currency. A currency pair can be bought or sold.

Buying Position (A “Long” Trade)

Purchasing a currency pair is a bullish trade. If the trader is buying the currency pair, the base currency is in the buying (or “long”) position. The quote currency is in the selling (or “short”) position. In our example, the trader is buying the USD and selling the CAD. Hence, the trader holds a bullish position on the USD and a bearish position on the CAD.

Selling Position (A “Short” Trade)

Selling a currency pair is a bearish trade. If the trader is selling a currency pair, the base currency is in the selling (or “short”) position. The quote (or secondary) currency is in the buying (or “long”) position. Using our USD/CAD example, the trader is selling the USD and buying the CAD. Hence, the trader holds a bearish position on the USD and a bullish position on the CAD.

Currency Pair Price

A currency pair will have a price assigned to it that will fluctuate throughout the trading period. The price could have four or five numbers and appear as 1.200, which means that it takes 1.200 units of the quote currency to purchase the base currency. If the currency pair price rises to 1.250, then the value of the base currency has risen against the value of the quote currency. For a trader holding a long (or buying) position, a profit was made. For a trader holding a short (or selling) position on this currency pair, a loss was incurred.

The Pip

The basic unit of price is called the “pip” in foreign currency trading. This is similar to stocks, which use dollars and cents as the basic unit. A Forex trader will refer to price movement in the number of pips that a currency pair has moved. The numbers at the end of the price are the most sensitive. In our 1.200 example, a 1 pip movement would change the price to 1.201 or 1.1999. It would take 100 pips to change the price to 1.300. And it would take 1,000 pips to change the currency pair price to 2.200. This type of dramatic pip movement is not common in Forex trading, but a long-term trend could see this level of price change.

The Lot

When entering a trade, the number of currency pairs purchased or sold is referred to as a “lot.” So, the trader can purchase or sell any number of lots of the USD/CAD currency pair. A lot controls 100,000 units of the currency price, making the pip worth .0001. This is important when determining the profit or loss on a trade.

Who Trades in the Forex Market?

Trading Forex was previously limited to institutions, large banks, central banks, multinational corporations, and governments. Very high net worth individuals were also allowed to trade Forex. For example, billionaire investor George Soros actively traded the British pound and, in 1992, was responsible for breaking the Bank of England! However, most individuals (known as retail traders) are excluded from directly trading Forex.

Individuals must trade through a bank. Retail traders make up only a small part (approximately 5 percent) of the Forex market. Many individual traders are attracted to the Forex market because of its high liquidity, 24-hour trading, easy access, and low cost. Most individual traders engage in speculation while others approach Forex from a hedging position.