What Is Forex Trading and How Does It Work?

Forex (FX) is a widely traded CFD asset class that’s prized for its liquidity and near-24-hour pricing. Perhaps even more attractive is that it gives you the flexibility to go long or short. 

If you’re new to the concept and asking what is forex trading or, more specifically, what is forex trading and how does it work, our practical guide will give you all the essentials in plain English, from what FX is to what moves currencies and the potential benefits and risks, as well as answering the question: how does forex trading work with CFDs? 

Key takeaways 

• Forex = currencies traded in pairs. You buy one currency and sell another (e.g. NZD/USD). 

• CFD trading lets you go long or short, so you can express views on rising or falling currencies without owning the underlying asset. 

• Spreads, funding/overnight holding and slippage can influence results. 

• Macro drives FX, which means central bank policy, growth, inflation, geopolitics and terms of trade are key movers. 

• Start with education, open a demo account and review our forex products and strategies. 

What is forex trading?

Foreign exchange trading (aka FX trading or forex trading) lets you speculate on price fluctuations within the FX market. The goal of forex trading is to forecast whether one currency’s value will strengthen or weaken relative to another currency.  

As a forex trader, you’ll encounter a number of different trading opportunities due to daily news releases. FX traders take advantage of this by becoming extremely receptive to market news and then trading based on the suspected market sentiment. 

Key forex trading terms explained

Base and quote currency: In a pair like NZD/USD, NZD is the base currency and USD is the quote currency. The price tells you how much of the quote currency it takes to buy one unit of the base, so an NZD/USD price of 0.60 means one NZ dollar buys 0.60 US dollars.

Pip: A pip is typically a one-digit movement in the fourth decimal place of a currency pair (the second decimal place for pairs involving the Japanese yen). If NZD/USD moves from 0.6050 to 0.6051, that's a one-pip move. Pips are the standard unit for measuring price change and calculating profit or loss in forex trading.

Learn more about pips in forex.

Lot: Currencies are traded in lots, or in other words, standardised batches of the base currency. A standard lot is 100,000 units, though mini and micro lots (10,000 and 1,000 units) let you trade smaller sizes. Because pip movements are usually small, lot sizes tend to be large to make trading meaningful amounts worthwhile.

How does forex CFD trading work? 

If you’re wondering how does forex trading work in a CFD account, the mechanics are quite straightforward: 

• Choose a pair and a direction: Go long (buy) if you expect the base currency to rise. Go short (sell) if you expect it to fall. 

• Size the trade: Positions are measured in units (e.g. micro/mini/standard lots of the base currency). 

• Manage risk: Keep an eye on funding/overnight holding if you keep positions open past the session’s cut-off. 

• React to information: FX is sensitive to economic releases (inflation, employment data), central-bank guidance, risk sentiment and more. 

What is leverage in CFD forex trading? 

When trading forex CFDs, leverage allows traders to control a larger exposure with less of their own funds. The difference between the total trade value and the trader’s margin requirement is usually ‘borrowed’ from the forex broker. Traders can usually get more leverage on forex than on other financial instruments, meaning they can control a larger sum of money with a smaller deposit. 

Since forex CFDs are traded on margin, you only have to deposit a percentage of the full amount you want to trade. Our margins start from 0.2%, which could be referred to as 500:1 leverage, as the value of the full position would be 500 times the value of the deposit required to open the trade. When trading on margin, it’s important to remember that your profits or losses are based on the full value of the position.​ 

What is spread in CFD forex trading? 

The spread in forex trading is the difference between the buy and sell prices of an FX currency pair. When you trade forex pairs, you’re presented with a ‘buy’ price that is often above the market price and a ‘sell’ price that is often below the market price. The difference between these two prices is referred to as the ‘bid-ask’, or ‘buy-sell’ spread. 

What moves the foreign exchange markets? 

Macro and policy dominate. Below you’ll find four highly durable drivers that you’ll see referenced in economic calendars and FX commentary all the time. 

Political instability and economic performance 

Political instability and poor economic performance can also influence the value of a currency. Politically stable countries with robust economic performance will usually be more appealing to foreign investors, so these countries draw investment away from countries characterised by more economic or political risk. 

Furthermore, a country showing a sharp decline in economic performance could see a loss of confidence and investment, as capital moves to more economically steady countries. 

Interest rates 

Interest rates, inflation rates and foreign currency rates are all interconnected, and as some rise, others can fall. Central banks control the interest rate as a measure to control inflation. If a central bank wants to decrease inflation, it can increase interest rates in a bid to stop spending and lending. This generally increases the value of money in an economy, as there is less, or ‘more expensive’, money available in the economy. 

On the other hand, when there is more money with less value in an economy, businesses and consumers increase spending and lending through loans and other types of credit. Sellers will then increase prices, causing inflation and a lower-valued currency. These fluctuations in currency value are one of the reasons forex traders may look to trade on interest rate announcements from central banks, like the US Federal Reserve or the Bank of England. 

Terms of trade 

The terms of trade for a country represent the ratio of export prices relative to import prices. If a country’s export prices rise and its import prices fall, the terms of trade have improved favourably. This increases the nation’s revenue and is followed by an increase in demand for the country’s currency. This increase in demand can cause a rise in the currency’s value. 

Debts 

A nation’s debt can be a large influencer in the variations of its currency price. Countries with large debts in relation to their gross domestic product (GDP) will be less attractive to foreign investors. Without foreign investments, countries can struggle to build their foreign capital, leading to higher rates of inflation and, thus, currency depreciation.​ 

What are the benefits of CFD forex trading? 

Some of the main benefits of CFD forex trading that make this asset class a popular choice among traders are: 

• The ability to trade on margin (using leverage). 

• High levels of liquidity mean spreads stay tight, which keeps trading costs low. 

• Prices react quickly to breaking news and economic announcements (this can be a disadvantage, too). 

• Trade 24 hours a day, Monday to Saturday (in line with global market hours). 

• The ability to go long and short. 

• Wide range of markets. 

Find out more about using leverage in forex trading. 

What are the risks of CFD forex trading? 

Some of the possible risks involved in CFD forex trading are: 

• You can lose more than your initial capital – leveraged forex trading means that both profits and losses are based on the full value of the position. 

• Risk of account close out – market volatility and rapid changes in price can cause the balance of your account to change quickly, and if you do not have sufficient funds in your account to cover these situations, there is a risk that your positions will be automatically closed by the platform. 

• Market volatility and gapping – financial markets may fluctuate rapidly and gapping is a risk that arises as a result of market volatility, and one of the effects of this may mean that stop-loss orders are executed at unfavourable prices​. 

Why trade forex with CMC Markets New Zealand? 

• A powerful platform: Advanced charting, drawing tools and integrated economic calendars help you analyse and act on opportunities fast. 

• Wide product range: Trade a massive selection of FX pairs alongside indices, commodities and more – all from one account. 

• Education first: Build your skills in the Knowledge Hub and learn about the best forex trading strategies. 

• Try before you trade: Practise on live-like prices with your own demo account, then move to live when you’re ready. 

• Get started quickly: Open an account and get familiar with our forex products. 

Ready to turn the theory of what forex trading is and how it works into a structured process?  

Start forex trading with CMC Markets New Zealand today.