The foreign-currency exchange, or forex, is the largest financial market in the world. Forex generates an average of $3.2 trillion in daily trading volume on the world’s major exchanges, according to the Bank for International Settlements. Operating around the clock and around the globe, the forex market is fast-paced and highly liquid. Corporations, financial institutions, and other large organizations are involved in forex trading as it serves to counteract or manage the risk involved with fluctuations in currency rates. The United States, European Union, Japan, Canada and the United Kingdom are leaders in foreign-exchange trading, and during recent years more investors have been drawn to forex trading as a viable investment option.
With all the hype on the Internet regarding forex trading and high-yield investment promises, the Commodity Futures Trading Commission cautions individuals against becoming a victim of Internet fraud. Countless fraudulent websites promise forex traders fast and easy money. So if you are interested in the market, be sure to use a registered futures broker.
Forex basics
A forex trade often is conducted in pairs; a spread is one example of this kind of futures trade because you are long in one position and short in the other. For example, Japan’s currency is the yen (JPY). If you were to purchase yen futures while shorting contracts on the U.S. dollar, it would be written as JPY/USD. As a spread trader, your goal is to choose a currency pair where the spread between the two prices is likely to widen and yield a profit.
Along with futures contracts, foreign currencies also can be traded as exchange-traded funds, an investment vehicle that tracks that currency’s price on the open market. As with futures, ETF’s also have options contracts available as another trading instrument. Options are traded on their own exchanges, as are futures contracts. In the case of options — whether it be for options on individual stocks, stock-index futures, commodity or currency futures or on ETFs, the largest is the Chicago Board Options Exchange. Trades you make through an online broker automatically will be routed to the proper exchange for execution.
Once you learn more about forex trading, you will begin to recognize trends in the market, similar to those investing in stocks. Foreign currencies, along with the U.S. dollar, often move in sync with the economies of their home countries. At the same time, a weak dollar often means higher prices for such commodities as oil and precious metals.
With stocks you are investing in your belief in the performance of a particular company, which involves its productivity, money management, debt ratio and likelihood to succeed. In forex trading, you are betting on a country’s monetary system as a whole. And, make no mistake about it, forex trading is much more like speculating than investing.
Terms and definitions
A few definitions of some of the terms you’ll need to understand include the following:
Bid – the price at which someone is offering to buy — whether it is shares of stock or futures or options contracts
Ask – the asking price at which someone will sell
Exchange rate – how many yen it takes to buy a dollar; how many dollars it takes to buy a euro or British pound, for example
Hedge funds – organizations usually restricted to wealthy individuals or institutional investors that often seek to hedge some of the risks inherent in their investments using a variety of methods, most notably short selling and derivatives. However, the term also also is applied to certain funds using short selling and other “hedging” methods to increase rather than reduce risk, with the expectation of increasing the return on their investment
Trading volume – number of contracts traded
Bid/ask spread – the difference between the bid and asking prices. A limit order often will be filled somewhere between the two
How to get started
The broker you choose should be registered as a Futures Commission Merchant (FCM). Reputable brokers also may be members of the National Futures Association, which can be verified through the NFA website.
In order to get started, you’ll need to fund your account through your broker and familiarize yourself with a professional trading platform. In order to get you up to speed on the learning curve, your broker should offer trading demo software or online sites that will allow you to simulate trades without using real money. “Paper trades” give you the opportunity to become familiar with trading and software with no risk to your funds.
Orders can be placed online or through your broker. From there they are filled on one of a number of futures or currency exchanges. Market orders usually are filled in just a few seconds; limit orders may take a bit longer to get the price you want.
What is the risk level?
Although the risk of losing money is high, there is an excellent opportunity to grow your wealth once you become more knowledgeable about trading. Once you make a few lucrative trades, your confidence and motivation to continue learning will increase.
There are two types of data with which you should be familiar, whether you are trading stocks or foreign currencies: technical and fundamental. Technical experts use analytical indicators, such as charts of moving averages, stochastics and other data. These features can help predict the movement of a market and offer buy or sell recommendations.
But it would be a mistake to rely exclusively on technical analysis while ignoring fundamentals. That’s because a technical system has no way to take into account market variables, such as economic upheavel, political unrest, or natural disasters that affect commodity, stock and currency values. Fundamental data includes economic reports and their likelihood to affect currency movements, for example. If a decision is made to raise or lower interest rates in the United States, for example, this would have an effect on the value of the U.S. dollar.
This information is useful because it looks at the actual source behind fluctuations, or the cause and effect factor. You should combine fundamental data affecting the markets, along with technical analysis of charts, to make your own trading decisions.
Tags: ask, bid, commodity futures, exchange traded funds, foreign currency, forex, limit order, market order, options, spread