How Forex Trading Works
Forex trading works by buying one currency and selling another, then closing the position at a later exchange rate. Your profit or loss depends on which direction the rate moves, how much currency you trade, and the costs of entering, holding and closing the position.
The mechanics matter as much as the forecast. A correct view on the euro can still produce a loss if trading costs outweigh the move. This walkthrough follows a retail trade from the price quote to the final account result. For broader background, see our forex trading overview. All prices and account figures below are hypothetical, not current market quotes or trade recommendations.
What You Trade Through a Forex Account
This article focuses on retail over-the-counter forex, usually shortened to OTC forex. You trade directly with a dealer rather than through a centralized exchange. As the CFTC explains about retail forex platforms, the trading application connects you to that dealer, which supplies the prices and spreads displayed on screen.
A speculative margin position is different from exchanging dollars for euros to spend abroad. You provide collateral to support currency exposure, rather than paying the full transaction value and receiving travel money. The NFA’s forex regulatory guide distinguishes these retail transactions from arrangements involving actual currency delivery.
That distinction gives you two separate questions to answer: what currency position are you taking, and which company is responsible for honoring the contract? A familiar trading platform does not answer the second question. Read the account agreement and identify the legal entity holding your account.
Reading a Forex Quote and Choosing a Direction
Each forex pair expresses one currency’s value in another. In EUR/USD, the euro is the base currency and the US dollar is the quote currency. A rate of 1.1000 means one euro is worth $1.10. The Reserve Bank of Australia explains this relationship in its guide to how exchange rates are measured.
A trading platform normally shows two prices. Suppose EUR/USD is quoted at 1.1000 bid and 1.1002 ask. You sell euros at the bid and buy euros at the ask. The difference, 0.0002, is the spread. The SEC’s forex investor bulletin explains why this difference creates a trading cost.
Buying EUR/USD means going long: you want the euro to rise against the dollar. Selling EUR/USD means going short: you want the euro to fall against the dollar. To close a long position, you sell the same quantity. To close a short position, you buy it back, as illustrated in OANDA’s profit and loss examples.
The direction applies to the relationship between the currencies, not either currency in isolation. Our guide to forex currency pairs explains how to read other combinations without reversing the trade you intended.
How Trade Size and Margin Work
Trade size determines the value of each price move
Forex price changes are often measured in pips. For EUR/USD, one pip is 0.0001. A movement from 1.1000 to 1.1050 is therefore 50 pips. Other quotation conventions exist, particularly for yen pairs, as explained in OANDA’s guide to pip measurements.
If you trade 10,000 euros against the dollar, each pip is worth $1: 10,000 × 0.0001. A 50 pip move therefore changes the position’s value by $50 before separate charges. At 1,000 euros, the same move is worth $5. The forecast has not changed; the financial exposure has.
Keep those two decisions separate. Choosing a direction does not tell you how much to trade. The relationship between units and platform volume settings is covered in our forex lot size guide.
Margin is collateral, not the trade’s maximum loss
Margin lets you support a position without depositing its full value. It is collateral set aside while the position remains open, not a purchase fee. Required percentages depend on the instrument and account rules; OANDA’s margin documentation shows how position value and the margin percentage interact.
Buying 10,000 euros at 1.1002 creates $11,002 of currency exposure. With an assumed 5% margin requirement, the opening collateral would be approximately $550.10, using the entry value for this simplified calculation. That percentage is an illustration, not a quoted requirement.
The $550.10 does not cap your loss. The CFTC warns that forex margin trading can create losses exceeding deposited funds. Review the account’s protections and obligations alongside its margin requirements.
How an Order Becomes an Open Position
An order tells the dealer what you want to trade and under what conditions. An open position exists only after execution. Entering an instruction is not the same as receiving a fill.
OANDA’s order documentation describes the main choices:
- Market order: requests execution at the available market price.
- Limit entry order: requests a purchase at a stated price or lower, or a sale at a stated price or higher.
- Stop entry order: waits for a trigger price beyond the current market before attempting entry.
You can also attach exit instructions. A stop loss seeks to close a position after an adverse move, while a take profit instruction seeks to close it after a favorable move. Check the pair, direction, quantity and exit settings before submitting the ticket.
The executed price can differ from the price you saw when submitting the order. This is called slippage, which the NFA addresses in its forex execution guidance. Treat the fill confirmation, rather than the earlier screen quote, as the record of your entry.
A Forex Trade From Entry to Exit
Suppose you have a $2,000 account and buy 10,000 euros at the EUR/USD ask price of 1.1002. The opening bid is 1.1000. Assume the dealer accepts the order at the displayed ask and requires the illustrative $550.10 margin described above.
Using actual entry and exit prices, the calculation for this long position is:
Profit or loss in dollars = (exit bid − entry ask) × euros traded
The possible results below exclude commissions and financing. They use the same price difference method shown in OANDA’s forex calculation examples.
| Scenario | Entry ask | Exit bid | Trading result |
|---|---|---|---|
| Close immediately at the unchanged quote | 1.1002 | 1.1000 | −$2 |
| Close after a favorable move | 1.1002 | 1.1052 | +$50 |
| Close after an adverse move | 1.1002 | 1.0952 | −$50 |
In the profitable case, the calculation is (1.1052 − 1.1002) × 10,000 = $50. Because the calculation uses the actual ask paid and bid received, the spread is already reflected. Subtracting it again would count the cost twice.
Now assume the trade also incurs $4 in total commissions and a $2.50 financing charge. The net profit becomes $43.50. With no other account activity, the balance after closing would be $2,043.50.
A short trade reverses the price calculation. Selling 10,000 euros at 1.1000 and buying them back at 1.0950 produces $50 before separate charges. Buying them back at 1.1050 produces a $50 loss instead.
What Happens to Your Balance While the Trade Is Open?
Balance records booked account activity, while equity also includes the current profit or loss on open positions. A floating gain is unrealized: it changes as the position’s valuation changes. OANDA’s account statement definitions distinguish open position valuations, realized results and margin used.
In the example, an immediate exit would lose $2 to the spread. Using that closing valuation and ignoring other charges, the balance remains $2,000 but equity is $1,998. Setting aside $550.10 as collateral does not itself reduce the balance to $1,449.90; collateral and a trading loss are different things.
Losses can nevertheless leave too little equity to support open positions. A dealer may then close positions under its margin closeout rules. Do not assume there will be time to transfer more money. Automatic closure is an account safeguard, not a substitute for deciding your own acceptable trade risk.
Trading Costs Beyond the Price Move
A spread is not necessarily the only charge. Some accounts also charge commission, and “commission free” does not mean cost free. The SEC warns that dealer charges may appear through spreads, commissions or both. Compare the complete cost rather than one advertised number.
Holding a position through the dealer’s daily rollover time can create a financing debit or credit. The amount depends on the currencies, trade direction and provider’s adjustments. For example, OANDA’s financing policy applies an overnight adjustment to positions held through its stated cutoff, with some dates covering multiple settlement days.
Account currency matters too. If the trade’s result is calculated in a different currency, it must be converted into your account currency, potentially with a conversion charge. Check how that appears on the statement rather than assuming every displayed profit figure is net. Our forex trading cost guide covers the fee categories in more detail.
Why Prices Move and When You Can Trade
Floating exchange rates respond to supply and demand. Interest rate differences, trade flows and changes in investors’ willingness to take risk can affect that demand. The Reserve Bank of Australia’s explanation of exchange rate drivers shows how these forces interact. No single economic release provides a dependable instruction to buy or sell.
Retail forex is generally available across the working week, from Sunday evening to Friday evening in New York time, rather than continuously through weekends. Exact access depends on the dealer and instrument. OANDA’s published trading hours, for example, include daily breaks and warn that prices can gap when trading resumes.
A gap can take the market past an ordinary stop loss price, producing a worse exit than planned. Check both the broker’s schedule and the relevant forex trading sessions before deciding how long to hold a position.
Checking the Process Before Risking Money
For a US retail account with a nonbank forex dealer, verify registration and disciplinary history before depositing. The CFTC’s registration checking guidance directs investors to the NFA BASIC database. Search the legal entity named in the account agreement, not just the brand advertised online.
Use a forex demo account to rehearse the mechanics: enter a quantity, inspect the margin estimate, submit an order, check the fill and close the position. Reconcile the result with your own calculation. Treat that exercise as platform practice, not evidence of future profitability.
Before a live order, be able to explain the trade in plain English: which currency you are buying, which you are selling, what each pip is worth, and what could happen if the exit is worse than expected. If any answer is unclear, the order is not ready.