Understanding Forex Trading
With easy access to online brokers, more and more people are looking to investing and trading to boost their incomes or build a retirement fund. If you have ever looked into trading and investing, Forex has probably come up at some point, but what is it, what can you do with it, and how can […]
With easy access to online brokers, more and more people are looking to investing and trading to boost their incomes or build a retirement fund. If you have ever looked into trading and investing, Forex has probably come up at some point, but what is it, what can you do with it, and how can you use it to build wealth?
What is Forex?
Forex is short for foreign exchange, and is the market for currencies, such as the US Dollar, British Pound, Japanese Yen, Euro and so on. Unlike stocks and shares, currencies are trading in what is called pairs, that is, the exchange rate between two different currencies.
For instance, this might be the $/€, where the price is the rate of exchange between the US Dollar and the Euro. If you have ever travelled to another country, you will have already experienced this, when transferring your own currency into that of your destination. Look past all the jargon, and that is essentially Forex trading.
It is, by far, the biggest market in trading, with an average of around $7.5 trillion per day across the various currencies, but you are probably wondering how you can make money with currency pairs.
How Forex Trading Works
A currency pair value will be in constant flux, so in our $/€ example, the dollar may be worth 0.9 Euros at one point in the day, and 0.95 Euros at other points. A Forex trade allows you to buy the currency at a value, then sell it later for a higher price (assuming you predicted it correctly). The difference between the two prices is your profit, minus a small fee for the Forex broker known as the spread.
Now, you might be thinking that a small rise in a currency is not going to make much money, but here is where it gets interesting. The Forex market is leveraged, meaning that you don’t just trade one lot of $/€ and see it go up by 2 cents. You trade 100s or even 1000s of lots at a time, so that 2 cent rise becomes $200, $2,000 and so on. You can do this without investing huge sums, as leveraging allows you to control larger amounts of currency without needing all the funds to buy it, instead of using just a portion.
But that is not all, and perhaps the biggest reason that so many love Forex trading, is that you can make money as the price falls too. The same rules apply, you buy at a lower price and sell at a higher price, with the profit being the difference between the two. The difference is, you sell into a position first, at a higher price, then as the market falls, you buy to exit a trade at that lower price.
It can seem confusing until you get the hang of it, but the result is you can trade and make money whether a currency is going up or down.
Understanding the Risks
So, Forex trading lets you make the most of your capital and increase your profits on winning trades, and because you can profit whether the markets are going up or down, there are more opportunities to win than in stocks for instance, but it is not perfect.
The leveraged market means you can make more profit with a given investment than you could in a similar trade in stocks, but it also increases the risk. If the trade goes against you, then the losses are bigger too. Volatility is also a double-edged sword. It means there are many more opportunities to make money, but also means that it is a challenging market to understand.
But for those with the patience to learn the market and use the available tools like effective stop losses, mitigate the risks, Forex trading is one of the most lucrative investment options out there today.