forex, short for foreign exchange, is trading where the
commodity is not stocks or shares, but currency.
the return for the investor is not in the value of the
currency per se, but rather the relative exchange value of one currency
against another currency. therefore forex trading is always expressed in
currency pairs such as us dollars and uk sterling or us dollars and euros.
by simultaneously buying and selling pairs of currencies,
the investor/speculator hopes to cash in on favorable exchange rate
fluctuations. like the interaction of gravity and airborne objects, though,
exchange rates go down as well as up. the trick in the black art that is forex
trading is accurately forecasting the direction of the fluctuation between two
currencies. change is frequently rapid and influenced by world events and a
multitude of other factors such as oil prices, interest rates and economic
climates.
the objective of any forex trader, naturally, is to make
a profit when the value of the currencies changes in favor of the investor.
plenty people certainly think that’s the case; the forex market is daily
worth on average in excess of $1 trillion. this staggering volume of buying
and selling of currency makes forex trading around 50 times larger than all
the futures markets combined!
so how do you make money in this massive marketplace?
for example, suppose you had $100 and bought euros when
the exchange rate was two euros to the dollar. you would then have 200 euros.
if the value of euros against the us dollar increased then you would sell
(exchange) your euros for dollars and have more dollars than you started with.
this scenario, simple as it is, is the nub of forex trading – buying and
selling currency when exchange rates move in the right direction.
now, all this sound fine and dandy, but what are the
risks?
surprisingly, compared with other money market trades,
the sheer scale of the forex market ensures greater price stability and better
leverage. with built-in protection in the form of automatic limits for buying
and selling, safety margins and other risk protection measures the likelihood
of ending up in the red even when the forex market is volatile is infinitely
reduced.
but all forex traders should note that the market is one
of the most liquid around and subject to strong currency trends. while
leverage figures of 100:1 are often times quoted, without adequate risk
protection in place the pendulum swing between profit and loss can be stark.
even veteran forex traders can be caught out and take large hits from time to
time. with this type of investor speculation, the golden rule must be: don’t
risk what you can’t afford to lose.