Introduction to Forex Trading: An In-Depth Analysis of the Forex Market Operation Mechanism and Trading Principles

What is Forex? An Essential Explanation of Trading

Forex (foreign exchange) trading is fundamentally a currency exchange activity. The most straightforward example is currency exchange when traveling abroad—exchanging your home currency for the local currency. However, in the financial markets, Forex trading goes far beyond simple exchange; it involves large-scale participation from international corporations, banks, institutional investors, and retail traders.

The core logic of Forex trading is to profit from fluctuations in exchange rates between different currencies. These fluctuations stem from relative changes in the economic strength of various countries. When a country releases good economic data, its currency usually appreciates; conversely, it depreciates when economic indicators are weak. Traders aim to anticipate these changes in advance, position themselves accordingly, and profit from the currency movements.

It is important to note that the Forex market uses a relative quotation system—always trading one currency against another. Therefore, when one currency appreciates, the other must depreciate or remain stable to create a favorable trading direction.

Key Characteristics of the Forex Market

Compared to other investment assets, the Forex market has unique advantages:

High Liquidity
The global Forex market has an average daily trading volume of several trillion dollars, ensuring ample counterparties at all times and minimal spreads.

Flexible Trading Hours
Covering multiple time zones, the Forex market operates nearly 24 hours a day. No matter where you are, you can always find active trading opportunities.

High Volatility
Exchange rates can change rapidly, offering traders quick profit opportunities but also increasing potential risks.

Low Entry Barriers
Through leverage trading, investors can control large positions with a small amount of capital. For example, a 400:1 leverage means investing just 250 euros can control a 100,000-euro position.

Bidirectional Profitability
Whether the market rises or falls, traders can profit by going long or short.

Easy Access to Information
Economic indicators, interest rate decisions, commodity discoveries, and other information are widely publicized, allowing traders to formulate strategies based on these data.

Factors Driving Exchange Rate Fluctuations

Understanding what drives exchange rate changes is the prerequisite for successful trading.

Most Direct Impact from Monetary Policy
Central bank interest rate decisions significantly influence exchange rates. Rate hikes typically attract more capital inflow, pushing the currency higher; rate cuts have the opposite effect. For example, the European Central Bank’s rate hike decisions directly strengthen the euro, reflected in the rise of EUR/USD and other currency pairs.

Economic Cycles and Growth Expectations
Economies in expansion attract more investment, increasing demand for their currencies. Good GDP and employment data can reinforce a currency’s strength.

Geopolitical Events and Sudden Incidents
Wars, terrorist attacks, major elections, and other political events can cause short-term sharp fluctuations. While markets tend to revert to fundamentals over the long term, short-term shocks should not be ignored.

Commodity Discoveries and Resources
Discoveries or development of natural resources can boost the economic outlook of related countries, strengthening their currencies.

Market Sentiment and Capital Flows
When large institutions or funds buy a currency to hedge risks, demand surges, pushing the exchange rate higher.

Fundamental Analysis Methods

Fundamental analysis involves studying macroeconomic data to predict currency directions. Traders focus on:

• Interest rate decisions and monetary policy statements
• Economic indicators like GDP, unemployment, inflation
• Political risks and elections
• Changes in commodity prices
• Shifts in market expectations

These data are often released weeks or months in advance, providing traders ample preparation time. Successful fundamental traders can connect these factors to judge the future strength or weakness of currencies.

Technical Analysis and Chart Trading

Technical analysis studies price charts and trading volume to identify market patterns. Core methods include:

Support and Resistance
Identify levels where prices repeatedly touch but struggle to break through. When approaching resistance, traders may short in anticipation of a reversal; near support, they may go long expecting a bounce. Be cautious: technical breakouts often occur around major fundamental news releases.

Trend Identification
Analyze price data from the past three months to determine long-term trends, identifying highs and lows. Once a trend is clear, trade along the trend.

Chart Patterns
Recognize specific formations (like triangles, flags, etc.) to forecast future movements.

Combining Technical and Fundamental Analysis
Relying solely on technicals may overlook major fundamental shifts. The most effective approach combines both—using fundamentals to determine medium-term direction and technicals to pinpoint entry points.

Practical Trading Example

Suppose you expect the European Central Bank to raise interest rates, which would strengthen the euro. You decide to go long 1 lot (100,000 euros) at EUR/USD 1.3536.

Using 400:1 leverage, you only need a margin of 250 euros. If your expectation is correct and the euro rises 50 pips to 1.3586:

Profit Calculation:

• Pips gained: 50
• Position size: 100,000 euros
• Per pip profit: 0.0001 × 100,000 = 10 euros
• Total profit: 50 pips × 10 euros = 500 euros
• After spread (about 1 pip): approximately 490 euros net profit

Risk Management:
If the market moves against you, set a stop-loss at 1.3486 to limit maximum loss to about 510 euros (50 pips plus spread).

This example demonstrates how fundamental analysis, appropriate position sizing, and stop-loss orders can keep risk under control.

Building Your Personal Trading Strategy

An effective Forex trading strategy should consider:

Personal Traits
Risk tolerance, trading frequency preference, available time—these influence suitable strategy types. Short-term scalping may only take minutes, while trend-following can last months.

Time Frame Selection
Intraday trading requires frequent monitoring; medium- to long-term strategies demand less time but patience.

Common Strategies

• Intraday trend following: identify main trend direction and trade with it
• Support and resistance trading: enter at key levels
• Economic data trading: position around major releases
• Arbitrage: exploit price discrepancies between related currency pairs

Choosing a strategy aligned with your personality and schedule is crucial.

Core Elements of Risk Management

The high volatility of Forex means risk and opportunity coexist. Effective risk management is essential for survival.

Stop-Loss Placement
Set stop-loss levels before opening a trade, defining maximum tolerable loss. This prevents losses from spiraling out of control.

Position Sizing Control
Avoid over-leveraging. It’s recommended that risk per trade does not exceed 1-2% of your account balance.

Emotional Control
The biggest enemy in trading is often oneself. During losses, traders may be tempted to “quickly recover” and take bigger risks, risking further losses. Strict adherence to your plan and calm judgment are vital.

Continuous Learning
Markets are constantly changing. Traders need ongoing experience and strategy optimization.

Keys to Success

Anyone who masters Forex understands one fact: Knowledge and discipline are equally important. Understanding market mechanics and learning analysis methods are fundamental, but true success comes from practical experience, respecting risks, and unwavering adherence to your strategy. Start with demo accounts, gradually gain real trading experience, and reflect on each trade to improve—this is the only way to achieve consistent profits.

The Forex (foreign exchange) market still carries high risks; invest cautiously.