Besides the obvious way of trading forex in the form of the physical foreign exchange transaction, a large part of forex transactions is executed by retail traders who trade forex pairs online for personal gain. As there is no physical exchange of currencies in online trading, forex pairs are traded via derivatives.

One of the most popular ways to trade currency pairs online is via CFDs – contracts for difference. If you are not familiar with the concept of derivatives or CFD trading, check out our CFD trading: a beginner’s guide, where we explain it in detail.

How to trade forex with CFDs

When you trade forex with CFDs, you predict the direction of a future price movement of a currency pair. If the price moves according to your prediction, you gain a profit, and if the market moves against your prediction, you incur a loss. Let's see how it works following simple forex trading examples from the previous What is forex trading article.

Imagine that the current buy price of the EUR/USD pair is 1.02839. Your research indicates that the euro will soon start strengthening against the US dollar, and the pair's price will go up.

You open a long (buy) CFD position on the pair. If your prediction is correct and the price goes up to 1.03039, the price difference – 0.0020 or 20 pips, is your profit. If the price moves in the opposite direction and goes down to 1.02639 instead, the price difference becomes your loss.

In the opposite scenario, where you think the price of the pair will decrease, you open a short (sell) position. If your prediction is correct and the price drops to 1.02639, you gain a profit of 0.0020 or 20 pips. Should the market move against your prediction and reach 1.03039 instead, you lose.

The USD 0.0020 seems like a small amount to win or lose. However, this number applies only to 1 unit of a currency – 1 euro in this example, while in CFD trading, currencies are traded in lots.

What is a lot in forex trading?

A lot in CFD trading (whether it's forex or any other financial market) is a measurement of a contract size. It usually varies depending on the market and instrument. In forex, one standard lot of all currency pairs is 100,000 units of a currency. So, one lot of EUR/USD would mean EUR 100,000. Most brokers allow traders to open much smaller positions, also called mini and micro-lots. With ThinkMarkets, for example, you can trade as little as 1,000 units of EUR/USD or EUR 1,000, which is 0.01 lot.

If you were trading one lot in our example, the amount of profit or loss – 0.0020 – would be multiplied by 100,000, resulting in a much bigger number:

With this formula, you can always calculate your potential profit or loss:

Now, if you trade one lot of EUR/USD, which means trading EUR 100,000, it may sound like a very large amount to open a trade with. However, when you trade CFDs, you don't need to pay the full amount to open a trade of that size because you trade with leverage.

What is leverage in forex?

Leverage is a term used to describe the process of borrowing funds from a broker to open trades larger than your capital. This term is not forex-specific and applies to any instrument and market traded with CFDs or other types of trading contracts that have this feature. We explain how it works in our CFD trading: a beginner’s guide too.
To give a brief example based on our EUR/USD currency pair, let's assume you are trading 1 lot with 200:1 leverage. It means that you only need to pay 1/200th part, or USD 500, to open this trade. The higher the leverage, the smaller the amount you need to deposit to open a trade.

Please keep in mind that using risk management tools when trading with leverage is crucial for every forex trader because while leverage increases buying power, it can also increase losses if a trade happens to be losing.

The maximum level of leverage depends on multiple factors, such as the broker's offering, account type, market, instrument, or country of trader's residence. For example, the maximum allowed leverage in the UK, Australia, and the EU is 30:1 due to regulating bodies within those regions, while in other parts of the world, it can be as high as 500:1.

However, there is a difference between maximum and optimal leverage, and very few people ever trade effectively at the maximum level, the same way you would not drive a sports car at top speed in a built-up area.

Instead, people will tend to trade with no more than ten times leverage. So, if a trader has deposited $10,000 to trade, they would rarely open positions larger than $100,000.

How to start trading the foreign exchange market

Here is a list of the first three important steps you need to do to start trading forex online:

Choose a forex broker

Most online trading brokers offer a variety of financial markets, not just currency trading, so you don't need to be focused on finding a forex-specific broker. It's crucial, however, to look for a well-regulated trading partner licensed by reputable regulators. ThinkMarkets, for example, has multiple licences and is regulated by the UK’s Financial Conduct Authority (FCA), the Australian Securities and Investments Commission (ASIC) and the Cyprus Securities and Exchange Commission (CySEC), among others.

Choose a trading platform

Most forex brokers usually offer several trading platforms. Explore your options and compare trading account types associated with them to find the one you are most comfortable with. Pay attention to the ease of use, offered spreads and leverage.

ThinkMarkets' proprietary trading platform, ThinkTrader, may be a good option if you are a manual trader. It offers a user-friendly, intuitive design, a wide variety of currency pairs, tight competitive spreads and fast execution. Available as a mobile and desktop app, as well as in a web browser, ThinkTrader is also equipped with a powerful suite of advanced tools to help you grow as a trader. Moreover, you can create a free demo account first and practise trading with virtual funds risk-free.

ThinkMarkets also offers MetaTrader 4 and 5 for traders who may prefer these platforms, and for their EA or custom indicator capability.

Choose a currency pair to trade

Most new traders tend to start their forex trading journey with the most traded major currency pairs because there is more information about them, and they present diverse trading opportunities. Here are some of the most popular forex pairs among beginners and experienced forex traders:

Keep in mind that there are quite a few factors that may cause price swings, so it is necessary to research before selecting a pair and placing a forex trade. In our next article, we'll find out what moves the forex market prices to help you identify potential trading opportunities. Once you have that knowledge, you can move on to getting to know trading strategies and building your own forex trading strategy.

You may also be interested in

What moves forex prices?

How to trade forex

CFD trading guide

You may also be interested in

What moves forex prices?

How to trade forex

CFD trading guide