What’s the difference between currency exchange vs forex trading?
Forex
Forex trading, also known as foreign exchange trading or FX trading, involves the buying and selling of currencies on the global forex market with the intent to make a profit.
Forex trading is conducted for two purposes:
- Speculation
- Hedging
Speculation: Traders buy and sell currencies, often using leverage, to profit from the change in exchange rates. This is known as speculation.
The use of leverage means traders can control large forex positions using only a small amount of their own capital, which is known as the margin amount.
Hedging: Banks, companies and investors trade forex to hedge against currency risk in international transactions and investments. This is known as hedging.
Currency risk involves the price of a currency changing before a transaction is complete.
This could result in the investor paying more or receiving less than expected at the start of the transaction, leading to financial loss.
Foreign Currency Exchange Services
On the other hand, foreign currency exchange services are businesses which cater to individuals and other businesses needing to convert one currency into another.
This is usually for practical purposes, such as holidaymaking and travel, the payment of international remittances, or sending money to family members in another country.
Unlike forex trading, foreign currency exchange services are not used for speculation or hedging.
Foreign currency exchange is a financial transaction, whereas forex trading is an investment activity.
Currency exchange services are commonly seen at airports, banks and at dedicated foreign currency exchange bureaus, catering to individuals and businesses needing to convert one currency to another.
However, there is also a huge market of online international money transfer service providers (such as Western Union, for example) who specialise in transferring money from one individual or company to another in a different country.
How does forex trading work?
The forex market is the largest and most liquid financial market in the world, with a daily trading volume exceeding US $7.5 trillion.
It consists of a network of banks, financial institutions, and individual traders who all buy and sell currencies together.
In the forex market, individuals exchange currency electronically in a global, decentralised market.
The market is an over-the-counter (OTC) market, which means participants effectively buy and sell to each other.
There’s no central exchange controlling the flow of currency.
Forex trading involves currency pairs
Forex trading involves buying one currency and simultaneously selling another.
Currency pairs are typically quoted in terms of the base currency, and the quote currency.
For example, EUR/USD means you’re buying Euros and selling US Dollars.
USD/JPY means you’re buying US dollars and selling Japanese yen, like in the example below:
There are eight main forex currency pairs in the world which are known as the ‘major’ currency pairs. These are:
- EUR/USD (Euro/US Dollar): This is the most traded currency pair in the world and reflects the value of the euro against the US dollar
- USD/JPY (US Dollar/Japanese Yen): This pair shows how much one US dollar is worth in Japanese yen. It is known for its liquidity and low spreads
- GBP/USD (British Pound/US Dollar): Also known as Cable, this pair represents the British pound against the US dollar and is influenced by economic data from both the UK and the US
- USD/CHF (US Dollar/Swiss Franc): This pair measures the value of the US dollar against the Swiss franc. The Swiss franc is considered a safe-haven currency
- AUD/USD (Australian Dollar/US Dollar): This pair reflects the value of the Australian dollar against the US dollar, often influenced by commodity prices, especially those of gold and iron ore
- USD/CAD (US Dollar/Canadian Dollar): This pair represents the US dollar against the Canadian dollar, with the Canadian dollar often being influenced by oil prices, given Canada’s status as a major oil exporter.
- NZD/USD (New Zealand Dollar/US Dollar) This pair measures the value of the New Zealand Dollar against the US dollar. It is often referred to as trading the ‘Kiwi’ because the NZ $1 coin depicts the Kiwi bird.
- EUR/GBP (Euro/British Pound) This pair measures the value of the Euro against the British Pound and is considered a relatively stable pair.
These currency pairs are the most liquid in the forex market, making them popular choices for the majority of traders.
However, there are also many additional minor currency pairs (also known as crosses) which do not involve the USD. These include:
| Minor Currency Pairs | ||
|---|---|---|
EUR/JPY | EUR/CHF | EUR/CAD |
EUR/AUD | GBP/JPY | GBP/CHF |
EUR/NZD | GBP/CAD | GBP/AUD |
GBP/NZD | CHF/JPY | AUD/JPY |
AUD/CHF | AUD/CAD | AUD/NZD |
NZD/JPY | NZD/CHF | NZD/CAD |
CAD/JPY | CAD/CHF | |
In addition to these major and minor pairs, there are more than 30 other currency pairs, which as known as the ’exotic’ pairs. They include such pairs as:
| Exotic Currency Pairs | ||
|---|---|---|
USD/SGD | USD/ZAR | USD/TRY |
USD/SEK | USD/NOK | USD/DKK |
USD/HKD | USD/MXN | USD/SGD |
USD/THB | USD/CNY | EUR/TRY |
EUR/ZAR | GBP/ZAR | EUR/PLN |
These exotic currency pairs are traded less often, so there is less volume of trades occurring worldwide.
This results in the exotic currency pairs being more volatile than the majors, and also experiencing more slippage.
Slippage is when a transaction is unable to be executed at the desired price due to lack of available volume at the required price.
Therefore, the nearest possible price is used for the transaction.
The difference between the desired execution price, and the actual price achieved is known as the slippage.
Forex trading permits long or short trades
Forex trading allows you to trade long or short, which means you place your trade based on whether you think the base currency is going to go up or down.
Going long means buying a currency pair with the expectation that its price will rise.
- When you go long, you are essentially buying the base currency and selling the quote currency. For example, if you go long on the EUR/USD pair, you are buying euros while selling US dollars, expecting the euro to appreciate against the dollar.
- You make a profit if the currency pair’s price increases after you buy it. You can then sell the pair at the higher price.
Going short means selling a currency pair with the expectation that its price will fall.
- When you go short, you are selling the base currency and buying the quote currency. Using the EUR/USD pair as an example, shorting it means you are selling euros and buying US dollars, expecting the euro to depreciate against the dollar.
- You make a profit if the currency pair’s price decreases after you sell it. You can then buy the pair back at the lower price.
Forex market participants
Major players in the forex market include:
- Banks: Large banks all over the world act as market makers, providing liquidity and facilitating trades
- Financial institutions: Investment firms, hedge funds, and insurance companies form a large part of the forex mix
- Individual traders: Retail traders access the forex market through online brokers, but account for only a tiny percentage of forex trades worldwide
The role of trading platforms in forex trading
Retail traders use electronic trading platforms to connect with other market participants and execute trades.
These platforms provide real-time quotes, charting tools, and order execution facilities.
Many of them also allow retail traders to connect with each other in social communities, where retail traders, particularly beginner traders, can chat and learn from each other.
Trading platforms are just like any other form of software that can either be downloaded as an app, or used through the web as a cloud-based platform.
Some of the popular trading platforms provided by forex brokers worldwide include:
- MetaTrader 4 (MT4)
- MetaTrader 5 (MT5)
- cTrader
- Match Trader
How do forex brokers make money?
Forex brokers make their money by charging a range of fees and commissions for facilitating the currency exchange.
These fees and charges may include:
- Spread – the difference between the buy (ask) price and the sell (bid) price of a currency pair
- Commission – a fixed fee or a percentage of the trade value, charged either per trade or per lot
- Swap/Rollover Fees – also known as overnight holding fees, these are charged applied when an open position is held overnight
- Currency Conversion Fees – if you trade in a currency that is different from your account’s base currency, the broker might charge a conversion fee, which is a small percentage added to the conversion process
- Inactivity Fees – some brokers charge a fee if your trading account remains inactive for a certain period
- Additional Service Fees – many brokers offer premium services for which they charge additional fees, such as advanced trading tools and VPS hosting.
VPS hosting is an essential tool for serious forex traders who rely on automated systems and require high server performance
How MarketMates is different from other forex brokers
MarketMates is different from most other forex brokers.
We never charge spread, swap or commission markups.
Instead, we offer subscription-based trading (SBT), providing unlimited no-markup trading for one flat monthly fee.
How do foreign currency exchange services work?
Foreign currency exchange services are also known as international money transfer services.
They allow you to exchange one country’s currency for another.
The amount of one currency you are able to purchase with another will depend on the international spot exchange rate, which is a changing value set by a network of banks that trade currencies.
These money exchange services make their money through markups on the spot exchange rate, or through charging fees to carry out the transfer.
Examples of international money transfer service providers include companies such as:
- OFX
- XE
- Instarem
- Western Union
- Wise
- TorFX
- Remitly
- Revolut
These companies compete for business by offering lower exchange rates than the big banks.
Therefore, they are in competition with the big banks for retail customers.
In many cases they also offer quicker money transfers, and may also offer additional services such as instant cash transfers.
This involves sending cash to an overseas destination, where it can be collected in person by someone at the other end of the transaction.
It’s can be a very useful service if a family member has an emergency overseas and needs immediate financial assistance.
However, be aware that higher fees may be charged for instant cash transfers, so the exchange rate you’ll be offered may not be the most competitive rate available.
It is also possible to transfer money to a person overseas who does not have a bank account, through pre-paid SIM cards and telecommunication companies using a mobile phone.
This is a popular method of transferring money internationally to people in countries where no banking facilities exist.
How and where can I access foreign currency exchange services?
Currency exchange services can be found either in physical buildings or offices, such as the money exchange booths at airports, or through online services.
The foreign exchange companies located at airports allow you to physically exchange bank notes and coins of one currency for another, either prior to your overseas visit or holiday, or when you return to your home country.
The exchange rate you will receive for such transactions will be the international spot exchange rate, plus any additional service fees or commissions the company may choose to charge for their services.
Online currency exchange usually takes place through a company’s app or web-based platform.
You’ll need to download the company’s app, or log into the online web-based service to take advantage of the currency exchange service on offer.
On these platforms or apps, you indicate the currency you wish to exchange, and the amount of currency you wish to exchange, and receive a quote for the transaction.
The quote is usually applicable for a set period of time, ranging from 30-mins to 24-hours.
If you accept the quote you are given for the exchange, you transfer the specified amount of base currency to the foreign exchange service provider, direct from your bank account or credit card.
You then receive the quoted amount of foreign currency, which is either held in an online app, or in an international bank account of your choosing.
It’s possible to use this foreign currency to pay bills in the quote currency, or to send it to another bank account as payment.
This system works in a very similar way to PayPal or ApplePay, and usually ensures instant payment or transfer.
Final thoughts
While forex trading and foreign currency exchange services both deal with currency transactions, they serve very different purposes
Forex trading is primarily speculative, and involves buying and selling currency pairs to profit from fluctuating exchange rates, often with the use of leverage.
The forex market is a highly dynamic, global market which offers risks and rewards for both speculators and institutional hedgers.
On the other hand, foreign currency exchange services are practical, enabling the conversion of one currency for another for travel, remittances, and international payments.
Till next time, happy trading!
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Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Investopedia – What is Forex https://www.investopedia.com/terms/f/foreign-exchange.asp
- Moneysmart.gov.au – Forex Trading https://moneysmart.gov.au/investment-warnings/forex-trading
