There are so many different investment instruments available today that it can be difficult to determine which is right for you. If you only have a small amount of investment capital that you are using as a means to get your “feet wet” in the investment marketplace, the decision can be daunting. This is why currency trading, often dubbed FOREX (foreign exchange) has become so popular. In fact, this type of trading is the fastest growing investment instrument in the world.
How Does FOREX or Currency Trading Work?
Basically, FOREX is the trading of currencies. Generally done through a brokerage or other financial institution, this type of investment essentially entails the purchase of one currency simultaneously with sale of another. Thus you are long one currency and short the other.
The simplest scenario is where one of the currencies is your own so if you normally buy and earn in dollars but think the Dollar will depreciate against the Euro you would go “short” the Dollar and “long” the Euro. Once you understand this relationship you can expand your horizons to other currencies such as how the Euro will fare against the Yen.
The key is to choose two currencies which are thought to have the highest potential for variance between their values. The idea is to try to take advantage of the fluctuations in the value of currency, allowing you to profit from the difference. This is done through the process of currency conversion, which allows for the trading between different currencies with different values. A crude example basic currency trading would be if you were on vacation in Mexico and decided that the Mexican currency was going to depreciate against the dollar so you went into a Mexican bank and borrowed 10,000 Mexican Pesos at 2% interest. You then took that money home and converted it into Dollars at a rate of 10 to 1. So you have $1000 which you put in the bank at 1% interest. A year later the exchange rate has moved to 12 to 1 and your $1000 has earned $10 interest. You still owe the Mexican bank 10,000 Pesos plus 2% interests or 10,200 Pesos. So you divide 10,200 by 12 (the current exchange rate) and find that is $850. So you withdraw $850 from your account and pay back the Mexican bank. Your profit is $1,010 – $850 = $160.
What are the Benefits of Currency Trading?
One of the biggest benefits of FOREX trading is the low initial investment required to get into this type of trading. Many investment firms have minimum investment amounts that are much higher than what the average investor might be able to manage. One can get started with FOREX trading for just a few hundred dollars.
It is easy to learn the basics of FOREX trading, though obviously, there are subtleties and other “tricks of the trade” that will be learned over time, making for better investment decisions. There are fewer choices in the FOREX market, as there are fewer currencies than there are stock options and even fewer “Major currencies” . This provides for more clarity in investment and the big picture isn’t muddied up by too many options.
Liquidity and Access
The other two big advantages of FOREX trading is its accessibility, both of the funds one invests and of the ability to invest itself. This is a highly liquid trading option which allows one easy access to their money if necessary. FOREX trading also provides remote internet access, now available on most mobile devices as well, which allow one to look in on their investments and make trades anytime, anywhere. The online FOREX trading market is open 24/7, except on weekends when the international currency markets are closed.
Low Correlation between Currencies and the Stock Market
The final advantage of the Forex market is its low correlation to the stock market. Curriencies move based on macro economic reasons. They also tend to behave like ocean-liners taking a long time to change direction. But they are still susceptible to sharp daily bounces so plotting the big trend is easier than timing the daily or intra-day changes.
Leverage
Because you are buying one currency and simultaneously selling another you don’t need a lot of money (the money for the purchase comes from the sale) but that means you have a lot of leverage. Which is good if the trade goes in your favor but bad if it goes against you. You could lose much more than you invested. So you need to be cautious and certainly begin by trading “paper money” or “Play Money” i.e. simulated trades.
While no investment is without its risks, the FOREX market has many benefits and can be highly advantageous to the shrewd investor. It does not require a large amount of capital to get started and it allows you the opportunity to trade anytime, anywhere.
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