Forex is a type of CFD. Forex – or FX - is an abbreviation for ‘foreign exchange’ and is used to describe trading in the foreign exchange market by investors and speculators. The Forex market is the largest and most liquid market in the world with daily turnover of around $5 trillion. The power and size of this market is phenomenal and it dwarfs all of the major stock exchanges around the world. (See Chart 1)
In a Forex trade, you are simultaneously buying one currency and selling another. The buy/sell decision in forex is the same as the basic principle underpinning the share market. If a trader believes that a company’s share price will rise (or the currency will strengthen), then he or she would buy. If a trader believes that the share price will fall (or the currency will weaken), then he or she would sell.
Let’s take the Australian dollar and US dollar pair (AUD/USD) as an example. Imagine a situation where the AUD is expected to strengthen in value relative to the USD. In this case, a trader would buy AUD and sell USD. If the AUD actually does strengthen in value, the purchasing power to buy US dollars has increased. Therefore, the trader is now able to buy back more USD than they had to begin with, resulting in a profit.