The investing essentials / 05
Forex, made understandable.
Learn how currency pairs work, why small price moves can matter, and what to check before trading.
01 / Currency pairs
One currency, priced in another.
Forex means foreign exchange. A currency pair tells you how much of one currency you need to buy another. EUR/USD at 1.1000 means one euro costs 1.10 U.S. dollars.
The first currency is the base; the second is the quote. Buying EUR/USD means buying euros and selling dollars. You benefit if the euro rises against the dollar, before trading costs.
See an exchange rate in action.
Fictional example · no leverage
You exchange $1,100 for €1,000 at EUR/USD 1.1000. What are those euros worth in dollars if the rate changes?
The dollar value is unchanged, before costs.
Same euros, new dollar value
Illustrates currency value, not a dealer’s contract or a forecast. Excludes spreads, commissions, financing, and taxes.
Which pairs will I see most often?
Common examples include EUR/USD, GBP/USD, USD/JPY, and USD/CHF. A cross such as EUR/GBP does not include the U.S. dollar. Always check which currency comes first: a rising USD/JPY means the dollar buys more yen.
What moves exchange rates?
Interest-rate expectations, inflation, employment data, central-bank decisions, and political events can affect demand for currencies. Markets react to expectations as well as news, so a strong economic report does not guarantee a currency will rise.
What are pips and lots?
A pip is a standard price increment, usually 0.0001, or 0.01 for yen pairs. Platforms may quote smaller fractions of a pip.
A lot describes trade size. Common conventions are 100,000 base-currency units for a standard lot, 10,000 for a mini lot, and 1,000 for a micro lot. Check the actual contract size.
Learn more: SEC’s introduction to forex ↗
02 / Costs and leverage
A small move can have a big impact.
Margin is money required to support a position. Leverage gives you exposure larger than that amount, magnifying gains and losses relative to your deposit. You can lose your entire deposit and owe more.
Look at the exposure, not just the deposit.
Simplified leverage illustration
Suppose $1,000 of margin supports $10,000 of exposure. A 1% adverse move on that exposure produces a $100 loss before costs.
A 1% move has used up 10% of the margin.
Same $100, two very different shares
The $100 barely shows against $10,000 of exposure, but it is 10% of the deposit.
Assumes simplified dollar-valued exposure. Actual results depend on the pair and contract. This is not a recommended leverage level or a regulatory limit.
Count the full cost.
The spread is the gap between buy and sell quotes. Commissions and overnight financing may also apply. Spreads can widen, especially around news or thin trading.
An exit price is not guaranteed.
A stop order can help plan an exit, but execution may be worse than the stop price. Fast moves, gaps, or platform problems can increase losses.
Know who is on the other side.
In retail over-the-counter (OTC) forex, you trade against your dealer. The dealer’s pricing, financial health, and withdrawal terms matter.
What happens if margin runs short?
Your dealer may require more funds or close positions under the account agreement. Forced closure can realize a loss. Read the margin and liquidation rules before entering a trade.
Does a 24-hour market mean I can always trade?
Forex generally operates through the business week, with activity moving across global financial centers. Dealer hours, holidays, maintenance, and liquidity vary. Check current schedules; daylight-saving changes can shift session times.
Read the risks: CFTC forex education and advisories ↗
03 / Before you trade
Understand the product and the provider.
“Can I explain what I’m trading, what it costs, and how much I could lose?”
Learning about currencies does not require opening a trading account. Use these checks to decide whether a product fits your circumstances.
Identify the product.
Retail OTC forex, exchange-traded currency futures, and currency funds work differently. Check the contract, costs, and protections for the exact product being offered.
Verify the firm independently.
For a U.S. nonbank retail forex dealer, check CFTC registration, NFA membership, and disciplinary history through NFA BASIC. Confirm the firm can serve your location. Registration is not a guarantee against loss or fraud.
Understand the account before funding it.
Read risk disclosures, financing charges, margin rules, and withdrawal conditions. Be wary of guaranteed returns or pressure to send money quickly.
Can a demo account prove a strategy works?
No. A demo can help you learn order entry and track a hypothetical plan. Simulated fills, costs, and emotions can differ from live trading. Scalping, day trading, swing trading, and longer-term approaches all carry risk; none guarantees a profit.
What belongs in a trading plan?
Write down the reason for a trade, position size, total exposure, expected costs, and exit conditions. Consider what happens if prices gap or an order does not fill. A plan can guide decisions, but cannot guarantee a maximum loss.
What about U.S. taxes?
Tax treatment depends on the currency product and your circumstances. Keep complete trade records and ask a qualified tax professional which rules apply. Do not assume retail OTC trades and currency futures are treated the same way.