Foreign Exchange Trading

Occasionally, changes in regulation open doors that give investors entirely new ways to make money. That is certainly the case with the much-hyped FOREX trading system, a method of exchanging foreign currencies through banks in the hopes of making a profit.

What is FOREX?

Throughout the world there are many different currencies; some, like the Euro, are shared by multiple countries and others are utilized within a single country, like the U.S. Dollar, the Yen and the Rupee. Each currency represents a fixed value when exchanged for goods and services within its country of origin but has a varying value when exchanged for the currencies of other countries.

Before the 1970’s most major countries had a fixed exchange rate so that currencies always had the same value in relation to the currencies of other countries. In the 1970’s a floating exchange rate was introduced that allowed each country’s currency to have a variable value based primarily on supply and demand. Because of this fluctuation in value, currencies suddenly became profitable to trade. This allowed for the introduction and viability of FOREX trading.

How Does FOREX Work?

When trading currencies, your goal is to buy a currency whose exchange rate appreciates so that you net a profit when you exchange it for your country’s currency. FOREX trading is done through banks rather than a central exchange. The banks determine both the bid and the ask price (buy and sell price) of the currencies. The difference between the bid and ask (also called the spread) is the profit that the banks make.

There are several different FOREX trading strategies. Many people like to try and spot trends in currency values based on the currency’s recent and historical value changes. Others like to determine their picks based on current events within the country itself. FOREX brokers also have proprietary algorithms and strategies to impart to investors.   

Risks and Rewards

Like any type of investing, FOREX comes with its own set of risks and rewards. Some are unique to the FOREX and others are shared by other types of trading.

Risks

• Loss of money: It is possible that you may buy a currency whose exchange rate depreciates rather than appreciating.
• Margin trading: Many FOREX trading platforms allow investors to trade on margin. When you trade on margin, it means the bank holding your account is essentially loaning you some of the funds you need to effectuate the trade. They charge you interest for the loan and you must make payments if the value of your currency falls past a certain percentage of the loan.
• Exchange rate: While the currency’s exchange rate may appreciate, if it does not match or outpace the appreciation in your home currency, your potential profit is at risk.

Rewards

• Unlimited upside potential: There are no limitations to the amount of money you can make as your currencies grow in value.

• Liquid assets: Unlike securities trading, currencies are already liquid. That means you don’t have to find a buyer, you merely have to exchange the currency to your home currency.

• Low transaction fees: FOREX trades do not have large commission charges like stock trades.

FOREX Trading

In order to begin FOREX trading, you must open a FOREX trading account with a bank. Not every bank is open to making FOREX trades since the market is largely unregulated; some larger multi-national banks like Deutsche Bank and Saxo Bank open retail FOREX trading accounts. There are also many independent trading systems found on the internet.

Although many websites might try to convince you that FOREX trading is easy, it is actually a sophisticated investment technique that should not be taken lightly. A FOREX broker can offer you sound, experienced advice so you can enjoy more of the rewards of FOREX and fewer of the risks.