Foreign exchange trading is a popular form of trading on financial markets that involves buying and selling currencies for gain. The foreign exchange market, known widely as the forex or FX market, is huge – in 2022 daily trading volumes reached US$7.5 trillion globally, according to the Bank for International Settlements.
This is when you buy a currency, such as US dollars, using another currency, such as South African rands. Because currency values are constantly changing in relation to each 
other, traders can profit from a difference in value between buying a foreign currency and selling it.
Say you buy US$100 at an exchange rate of R18 to the dollar, costing you R1 800. If the rand weakens against the dollar and the exchange rate moves to R20/dollar, you will be able to sell your dollars for R2 000, making a profit of R200. However, if the rand strengthens and the rate moves in the other direction to R16 a dollar, your $US100 will be worth only R1 600 in rand terms, meaning you will have made a loss of R200.
FX trading exists on different levels. The major participants in this market are large corporations and financial institutions, where trades are often used to hedge (protect the value of an asset priced in a certain currency). In the last couple of decades, however, online broker platforms have brought the FX market within reach of the consumer.
Trading on retail FX broker platforms does not involve the actual buying and selling of hard currency. You open a trading account, deposit money into the account, and trade using an instrument known as a contract for difference (CFD).
A CFD is a contract between you and the broker based on the difference between the buying price and the selling price of the currency traded. The broker contracts to pay you the difference if the price goes up and deducts the difference from your account if the price goes down.
FX trading may also involve leverage. This is when the broker “lends” you a portion of the money for a trade. For example, on a R1 000 trade, you may put in R200 and the broker will provide the remaining R800. If the price rises to R1 200, you make R400 profit after returning the R800. In other words, you have made 100% profit on the price rising by 20%. This practice, known as “trading on margin”, works against you when you make a loss. If, in the example above, the price fell by 20% to R800, you would have lost your entire R200.
Most trading is in the world’s major currencies. The two currencies in a trade are known as a currency pair – an example is the EUR/USD pair for trading the euro against the US dollar. The currency on the left is known as the “base” currency and the one on the right is the “quote” currency. The value of the base currency is fixed at a single unit, while the value of the quote currency varies.
Using these pairs, you can trade on the spot prices of the currencies, which are their prices in real time. Trades can be over the short- or longer term, ranging from just a few seconds or minutes to days, weeks or months.
On the trading platform, the currency pairs are shown with an “ask” price (the price at which you may buy) and a “bid” price (the price at which you may sell). The prices are quoted to five decimal points (for example 1.85413) and the difference between the “ask” and “bid” prices is known as the “spread”.
The fourth digit after the decimal point is called a “pip” and the fifth digit a “point”. Extreme short-term trades are often done on differences in pips and points, taking into account the spread.
Currencies are traded in “lots”. One lot is 100 000 units of the base currency, and the minimum you can trade is one micro-lot, which is 1000 units. This is still out of reach for many people (US$1000 equals about R18 000). Leverage makes FX trading affordable, although it increases the risks.
The FX market is extremely volatile, with short-term trading especially so. Interest rates, trade flows, the varying strength of nations’ economies, and geopolitical issues affect the supply and demand for currencies, creating this volatility.
Traders operate according to the following time frames:
Trading platforms provide charts that give users a picture of price movements over these different time frames.
The advantages of FX trading are:
The market has high liquidity. High trading activity ensures that it is easy to enter and exit positions in fractions of a second.
The market is open 24 hours a day.
Leveraged trading can multiply your gains.
By using leverage you don’t need a large initial amount to start trading.
The disadvantages are:
The FX market is far more volatile than the stock market and the bonds market.
Leveraged trading can multiply your losses.
Unlike stocks or bonds, there is no income component to holding a foreign currency.
The FX market is less regulated than other financial markets.
There are many scam websites offering FX trading. You need to ensure that the platform you use is legitimate. Trading sites catering to South Africans must be registered under the appropriate licence with the Financial Sector Conduct Authority.
