Forex Basics

What Is Forex?

Forex is the acronym for Foreign Exchange. The foreign exchange market is the "place" where currencies are traded, and it exists because currencies need to be exchanged in order to conduct foreign trade and business.

Currencies are important to most people around the world, whether they realize it or not. If you are living in India and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the Indian importer would have to exchange the equivalent value of Indian Rupees (INR) into euros. The same goes for travelling — a French tourist in Egypt can't pay in euros to see the pyramids, because it's not the locally accepted currency. The tourist has to exchange the euros for the local currency, in this case the Egyptian pound, at the current exchange rate.

The need to exchange currencies is the primary reason why the forex market is the largest, most liquid financial market in the world. As per a 30 September press release by the Bank for International Settlements (BIS), global FX trading hit $9.6 trillion per day in April 2025. The US dollar maintained its place as the most traded currency, being on one side of 89% of all FX trades in April 2025, followed by the euro and the yen.

One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted either through brokers or electronically over-the-counter (OTC), meaning transactions occur via computer networks between traders around the world, rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centres of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney — across almost every time zone. When the trading day in the U.S. ends, the forex market begins anew in Sydney, followed by Tokyo and Hong Kong, keeping price quotes changing constantly.

Forex is used by anyone exchanging currency for any reason:

• Travel
• International Trade — Import/Export
• Central Authorities
• Investments/Borrowings in Foreign Currency

How Forex Rate Movements Can Affect an Economy

Movement in the foreign exchange market can have a big influence on the planning and determination of monetary policy of any economy. Sometimes this policy is formulated on the basis of assumptions made by economic planners about international currency trends. Broad areas where forex can impact the economy include:

• Monetary Policy — The pattern of international currency flow in and out of an economy may influence domestic money supply, and hence monetary policy. This in turn also affects interest rates.
• Consumer Prices — A proportion of all consumer goods are imported. Currency fluctuations and the price of the importer's currency versus the exporter's currency will influence the cost of goods sold at home.
• Inflation — Inflation is the process of steadily rising prices, resulting in the diminishing purchasing power of a given sum of money. The price of imports, of which exchange rates are a factor, can directly affect inflation levels in an economy.
• Exports — The performance of the home currency against foreign currencies on international markets directly influences the competitiveness of exports. If a currency is undervalued, exports appear relatively cheap to holders of foreign currency, increasing export volumes.
• Employment — Inflation and export competitiveness have a direct bearing on employment levels, particularly in export-oriented industries. Cheaper import substitutes (due to currency fluctuations) may also hurt employment in home-based industries.

Factors Influencing Exchange Rates

The actual exchange rate, at any given time, is primarily determined by the supply and demand conditions for the relevant currencies. Key factors that influence supply and demand — and therefore the exchange rate — include:

• Balance of Payment — A currency tends to fluctuate according to its country's performance with its trading partners. With a surplus, a currency tends to strengthen; with a deficit, it tends to weaken, since more foreign currency must be bought to pay for imports, dropping the exchange rate. This makes imports more expensive but exports cheaper and more competitive.
• Interest Rates — As the prevailing interest rate of one currency rises or falls relative to another, the currency with the lower interest rate tends to be sold and the one with the higher rate tends to be bought, to avail of higher returns — raising its price.
• Government Policies — Central Banks are often seen buying or selling local currency to stabilise it at levels perceived to be realistic, in line with government policy on deflation or reflation.
• Political Development — The stability of a currency very often moves in line with the stability of the political situation, both domestically and globally. Increasing world tension can cause dramatic flights in and out of various currencies.
• Market Sentiment — The forex market does not always follow a logical pattern. Intangible factors such as gut feelings, individual perceptions and analysis of international, political and economic events all play a role.
• Speculation — Speculative activity by large market operators can be a determining factor. A large proportion of forex volumes are speculative in nature, and this can cause runs on various currencies.

Understanding Currency Pairs

In the world of forex, currencies are called currency pairs — one currency expressed in terms of another, like USD/INR, USD/JPY, USD/CHF, GBP/USD, EUR/USD. The currency to the left of the slash is the base currency, while the currency on the right is the variable or counter currency. Currency pairs are quoted on a Bid–Ask basis.

The difference between the bid price and the ask price is called a spread. Looking at the quote EUR/USD = 1.1800/1.18005, the spread would be 0.0005, or 5 pips (also known as points). Although these movements may seem insignificant, even the smallest point change can result in thousands of dollars being made or lost due to leverage — one reason speculators are so attracted to the forex market.

The pip is the smallest amount a price can move in any currency quote. For the U.S. dollar, euro, British pound or Swiss franc, one pip is 0.0001. For the Japanese yen, one pip is 0.01, since this currency is quoted to two decimal places. So in a forex quote of USD/CHF, the pip would be 0.0001 Swiss francs.

There are two ways to quote currency pairs — direct or indirect. A direct quote expresses the price of one unit of a foreign currency in terms of a variable number of units of the domestic currency, using the foreign currency as the base. An indirect quote shows the amount of foreign currency needed to buy or sell one unit of the domestic currency, using the domestic currency as the base.

In the forex market, most currencies are traded against the U.S. dollar, which is frequently used as the base currency — a direct quote, like USD/INR, USD/JPY, USD/CHF, USD/CAD. However, currencies that have historically been tied to Britain — the British pound, Australian dollar and New Zealand dollar — along with the euro, are all quoted as the base currency against the U.S. dollar. In these cases the U.S. dollar is the counter currency, and the exchange rate is an indirect quote, like EUR/USD, GBP/USD, AUD/USD, NZD/USD.

When a currency quote is given without the U.S. dollar as one of its components, this is called a cross currency, like EUR/INR, JPY/INR, or GBP/INR. The most common cross currency pairs are EUR/GBP, EUR/CHF and EUR/JPY. These pairs expand trading possibilities in the forex market, though trading volumes in these pairs are typically lower than in pairs that include the U.S. dollar — commonly called the majors.

Two Fundamental Types of Exchange Rates

In the forex market there are fundamentally two types of exchange rates for any transaction:

• Spot Rate
• Forward Rate

The spot rate is the current price at which currencies are bought and sold in the FX market — an existing, day-to-day exchange rate. Although the spot market deals with transactions in the present rather than the future, these trades actually take two business days for settlement. This price, determined by supply and demand, reflects current interest rates, economic performance, sentiment towards political situations both locally and internationally, and the perceived future performance of one currency against another. When a deal is finalised, this is known as a "spot deal" — a bilateral transaction where one party delivers an agreed-upon currency amount to the counterparty and receives a specified amount of another currency at the agreed exchange rate.

Several transactions in the FX market are settled sometime in the future — the rates at which these are done are called forward rates. A forward rate is an agreed-upon exchange rate for a future transaction, derived from the spot rate and adjusted for market expectations and the cost of carry.

The main difference between spot and forward dealing is that spot dealing concerns tactical short-term decisions, while forward dealing involves a longer-term view on interest rate movements. The forward market typically operates between overnight and one year. Forward rates are determined by interest rates prevailing in the deposit markets of the two currencies involved, and are usually quoted in points — added to or subtracted from the spot price depending on whether the points are quoted low figure–high figure (added) or high figure–low figure (subtracted). The forward rate is therefore expressed at par, at a premium, or at a discount.

Forward rates are used for hedging against currency and interest rate risks, enabling businesses and investors to protect themselves from unfavorable market fluctuations.

• Forward Outright
• Forward Swaps

Forward Outright transactions are an agreement to buy or sell a specific amount of currency against another at a specified rate (the forward rate) on a fixed date in the future, typically beyond the two-day spot settlement period. The primary purpose is to hedge currency risk, ensuring a locked-in exchange rate for future transactions such as imports and exports.

A Forward Swap transaction is the simultaneous buying and selling of the same amount of a given currency, against the sale and purchase of another, at an agreed-upon rate for two different fixed dates in the future.

Forward swap transactions can be either:

• Spot-Forward Swap: Buy/sell currency in the spot market and reverse it at a future date.
• Forward-Forward Swap: Buy/sell currency at a future date and reverse at a future date.