How to read the foreign exchange market? A beginner's essential guide to currency trading

Many novice forex traders share a common question: Are we really dealing with money in the forex market? When you buy EUR/USD, do these euros actually transfer to your account? The answer might surprise you.

Do You Think You’re Buying and Selling Currency, But What Are You Really Trading?

The essence of forex trading is currency exchange trading. But here’s a key point: most retail traders are not buying or selling real physical cash or digital currency itself.

Imagine that when you click “Buy” EUR/USD on the platform, you are actually entering into a contract with the platform. This contract stipulates: if the euro appreciates, the platform pays you; if the euro depreciates, you pay the platform. Neither party needs to settle actual euros or dollars; instead, they settle the price difference based on price movements.

This is why you can sell EUR/USD even if you don’t hold euros. You’re not trading the currency itself, but rather making a bearish prediction on the exchange rate movement.

How Is the Exchange Rate Actually Determined?

The exchange rate is essentially the price of one currency relative to another. For example, EUR/USD at 1.3000 means 1 euro costs 1.3000 dollars.

Where does this price come from? Mainly from the spot forex market. In this market, countless forex dealers continuously quote prices, which are determined by supply and demand. Think of it like a marketplace: some want to buy euros (buyers), others want to sell euros (sellers), and the final transaction price is the spot rate.

Because the forex market is decentralized, different dealers may offer slightly different quotes. The exchange rate you see on your personal trading platform is actually adjusted based on the spot market quotes. Most retail traders are not seeing the real-time spot price but a quote provided by the platform.

How to Read the Exchange Rate to Make Money?

This is the part traders care most about. Suppose you observe EUR/USD at 1.3000 and predict the euro will appreciate, so you buy 1,000 euros with 1,300 dollars.

After some time, as you predicted, the rate rises to 1.4000, and you decide to sell. Now those 1,000 euros are worth 1,400 dollars, earning you a net profit of 100 dollars.

How is this 100 dollars generated? Simply put, you and the platform agree: neither side transfers real currency, but settle the price difference based on the exchange rate movement. Your bullish prediction was correct, so the platform pays you this difference.

This process is carried out through a financial instrument called Contract for Difference (CFD). The biggest feature of derivatives is that you don’t need to own the underlying asset; you only need to predict its price movement to profit.

Three Core Concepts of Exchange Rate Trading

1. Base Currency vs Quote Currency

In the EUR/USD currency pair:

• The euro on the left is the base currency
• The dollar on the right is the quote currency
• An exchange rate of 1.3000 means 1 euro costs 1.3 dollars

2. Bullish vs Bearish

• If you predict the euro will appreciate, click “Buy” (go long EUR/USD)
• If you predict the euro will depreciate, click “Sell” (go short EUR/USD)

3. Price Difference Settlement Mechanism

Whether you buy or sell, ultimately, you only settle the price difference:

• If the market moves in your predicted direction, you profit
• If it moves against you, you incur a loss
• The profit or loss could be $100, $1,000, or more, depending on your position size and the extent of the exchange rate movement

Why Is It Important to Understand These?

Grasping how to interpret exchange rates is not just theoretical knowledge but the foundation of successful trading. When you understand that you’re actually trading a contract and predicting the price direction, you will:

• Stop fantasizing about “receiving real money”
• Focus on technical and fundamental analysis
• Develop scientific risk management strategies
• Avoid blindly following the crowd

Forex trading has a low barrier to entry, but to do well, you need a deep understanding of how exchange rates work. Starting today, turn your knowledge of how to read forex into practical skills and gradually build your own trading system.