Foreign Exchange Investing, or Forex investing, as it is more commonly known, is the art and science of making money from the natural fluctuations in currency values. Based on supply and demand, the currencies of countries are constantly moving slightly up and down in value. The key to forex, much like stocks, is attempting to predict which way one will move, and making a bet based on your information. In fact, although the forex market doesn’t get very much media attention, it is actually the most valuable market in the world, with over 4 trillion dollars’ worth of transactions occurring around the clock in major financial capitals around the world. So, in turn, let’s look at what exactly forex is, how one can make money in these markets, and how to go about getting started.
What is Foreign Exchange?
So what exactly are the foreign exchange markets, why do they exist, and most importantly, how do they work? One could write books to answer these questions, but to make things as simple as possible, let’s take a look at what Earnforex.com has to say on the subject:
The foreign exchange market or currency market or Forex is the market where one currency is traded for another. It is one of the largest markets in the world…In the foreign exchange market there is little or no ‘inside information’. Exchange rate fluctuations are usually caused by actual monetary flows as well as anticipations on global macroeconomic conditions.
Due to the huge number of goods and services traded internationally, it is easy to understand how this market became the largest market on the planet. And, while you can make a lot of money trading on the forex, you really need to do your due diligence before making your first investment, and every other investment afterwards.
Making Money in Foreign Exchange
Before we can look at how one makes money in the foreign exchange market, it is important to understand the general structure of the market. There are actually three forex markets: There is the spot market, where you simply trade one currency in real time, and the forwards and futures markets, where you are making a contract to buy a given currency at a set price and set time.
Buying in the spot market, you are looking to buy a currency that you think will move up in value, or to get out of a currency that you think will drop in value. For example, if you think that the Canadian economy is about to outperform the US economy, you would want to trade your US dollars for Canadian dollars. According to Investopedia.com;
You can also think of buying currencies as buying shares in a country, you are betting on the success or failure of a particular country’s economy.
The forwards and futures markets are typically used a bit differently. In these markets, you buy a contract to buy or sell a currency at a date and rate in the future. These are more often used by large corporations looking for a hedge against potential currency fluctuations, and by speculators who want to make highly leveraged bets on the possible movement of currencies. These markets are not quite as important for the beginning forex trader.
Risks and Benefits
There are several major benefits to trading in the forex markets, including the size of the market and the fact that it is open 24 hours per day. Additionally, highly leveraged positions are common in the market, especially when making bets in the forward and futures markets. Using leverage means to effectively borrow money in order to increase the potency of your bets. Leverage of 100:1 isn’t uncommon in the forex market. If you have invested capital of $1000, your broker will typically allow you to leverage it at 100:1, meaning that you effectively control 100,000 dollars. While this leverage brings a lot of excitement to trading in the forex market, it can also be a double-edged sword, as you can lose all your principal capital due to a small fluctuation in the exchange rate.
Getting Started
Getting started with forex trading is actually a three step process, which we will go into in some detail here.
Select a Broker – The first step is choosing who you will execute your deals with. This is much like selecting a stock broker. As with choosing a stock broker, there is no best broker out there, do a review of the features that each one offers and choose a company that makes you feel comfortable. Don’t worry too much, as there won’t be real money on the line, yet.
Open a Demo Account – Once you’ve selected a broker, this is the next step. Don’t select a broker unless they give you the option to make a demo account. A demo account, as the name suggests, offers you the chance to make live trades, as if you are actually poised to make or lose money, but without actual money on the line. This allows you to understand the technical aspects of the market and optimize your trading strategies without actually risking any real money. If this seems like an unnecessary step, consider the following statements from one of the forex experts at About.com:
Using a demo account is a good opportunity to make sure that you feel comfortable using the broker’s trading tools. You would not want to trade real money without being fully comfortable with the trading platform.
Make Your First Trade – This is where it gets real! Using the strategies outlined here, as well as your own personal theories that you’ve developed while working with the demo account, make your first trade. Make a bet and act on it.
Hopefully this has given you a bit of insight into the exciting world of foreign exchange, an appreciation of the potential to make serious money as well as the risks, and some information on how to get started. However, this is by no means a comprehensive guide. Check out some of the other articles on this site for more ideas about forex trading.
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