Foreign exchange trading made easy
The blanket term "Forex trading," properly called "foreign exchange trading" but also known simply as "FX," is used to describe speculative investments in foreign currency. Every day, more than US$3 trillion is traded globally on Forex markets, making it the largest investment market in terms of the actual dollar amount that changes hands on a daily basis.
Private investors make heavy use of the Forex trading system; governments and financial institutions represent only a relatively small percentage of the trades made on a daily basis, as they usually don't need to trade heavily to meet their currency conversion needs.
Types of Forex Trades
A straight currency trade is the most common type of foreign exchange transaction made through a Forex broker. In this type of transaction, an investor simultaneously buys one currency while selling another. This is performed when the currency being bought is available at an advantageous exchange rate.
Margin trading can also be done on Forex markets. With this type of transaction, an investor can trade far more capital than he or she actually has available in his or her account by invoking margin spreads. This is riskier, since the investor is responsible for making up any shortfalls between the money made available on margin and his or her actual losses in the event that a loss is sustained. However, it has the advantage of allowing the investor to take advantage of smaller market fluctuations by using larger amounts of money to generate profits.
Risks and Benefits of Forex Trading
Whether you're using a Forex broker for your transactions or placing them yourself through an online Forex trading account, you should have a full understanding of the risks as well as the benefits of investing in foreign currencies. All speculative investments carry varying degrees of risk, and Forex trading is no different.
In addition to the possibility of making a losing trade, some of the less obvious risks you should be aware of include:
- Exchange rate risks. Prices fluctuate very rapidly on Forex markets. If you have open orders, they may be filled at a different rate than you expected; thus, it's vital that you stay up-to-the-minute on prices and issue stop orders if the price moves above or below a specific threshold.
- Interest rate risks. If the centralized interest rates differ between the two countries whose currencies are being exchanged, the investor may find a discrepancy between his or her expected gain or loss and the actual gain or loss. Investors are responsible for covering all expenses associated with currency purchases and sales, though interest rate risks generally affect only sizeable transactions.
- Credit risks. If a Forex transaction results in a loss for one trading party, that party may not honor its obligations. For example, a bank losing a large sum of money on a foreign exchange trade may be forced to declare insolvency, leaving the investor on the other end of the transaction without his or her profits.
- Foreign government risks. Not all countries allow for the free trading of their currencies. Thus, they may limit the amount of currency available for trading on open markets, which could leave investors unable to complete transactions.
Forex trading does offer numerous advantages to the investor, though. These include:
- 24-hour trading. The Forex market only rests on Saturdays and Sundays. Otherwise, you're free to take advantage of positive opportunities no matter when they present themselves.
- Market liquidity. Financial institutions back most of the world's Forex trading, resulting in superior liquidity. This also helps keep prices stable and spreads narrow.
- No commissions. If you use an online Forex trading account, you won't have to pay commissions to anyone on your transactions. This leaves more money in your pocket after a winning trade.
- 100:1 margin leverage. If you choose to venture into margin trading territory, you can open a position worth up to 100 times the actual amount of money you have in your account.
- Falling markets hold opportunity. You can always profit from a currency trade, whether the currency you're buying is moving up or down in value. Because currencies have inherent value, you can also hold them until they recover from a loss, if you incur one.
If you educate yourself and make conservative investments until you gain the confidence to complete more complex transactions, you can profit from Forex trading. It's one of the most exciting and dynamic ways to build personal wealth.