For those unfamiliar with the term, FOREX (FOReign EXchange market), refers
to an international exchange market where currencies are bought and sold.
The Foreign Exchange Market that we see today began in the 1970's, when free
exchange rates and floating currencies were introduced. In such an
environment only participants in the market determine the price of one
currency against another, based upon supply and demand for that currency.
FOREX is a somewhat unique market for a number of reasons. Firstly, it is
one of the few markets in which it can be said with very few qualifications
that it is free of external controls and that it cannot be manipulated. It
is also the largest liquid financial market, with trade reaching between 1
and 1.5 trillion US dollars a day. With this much money moving this fast, it
is clear why a single investor would find it near impossible to
significantly affect the price of a major currency. Furthermore, the
liquidity of the market means that unlike some rarely traded stock, traders
are able to open and close positions within a few seconds as there are
always willing buyers and sellers.
Another somewhat unique characteristic of the FOREX money market is the
variance of its participants. Investors find a number of reasons for
entering the market, some as longer term hedge investors, while others
utilize massive credit lines to seek large short term gains. Interestingly,
unlike blue-chip stocks, which are usually most attractive only to the long
term investor, the combination of rather constant but small daily
fluctuations in currency prices, create an environment which attracts
investors with a broad range of strategies.
How FOREX Works
Transactions in foreign currencies are not centralized on an exchange,
unlike say the NYSE, and thus take place all over the world via
telecommunications. Trade is open 24 hours a day from Sunday afternoon until
Friday afternoon (00:00 GMT on Monday to 10:00 pm GMT on Friday). In almost
every time zone around the world, there are dealers who will quote all major
currencies. After deciding what currency the investor would like to
purchase, he or she does so via one of these dealers (some of which can be
found online). It is quite common practice for investors to speculate on
currency prices by getting a credit line (which are available to those with
capital as small as $500), and vastly increase their potential gains and
losses. This is called marginal trading.
Marginal Trading
Marginal trading is simply the term used for trading with borrowed capital.
It is appealing because of the fact that in FOREX investments can be made
without a real money supply. This allows investors to invest much more money
with fewer money transfer costs, and open bigger positions with a much
smaller amount of actual capital. Thus, one can conduct relatively large
transactions, very quickly and cheaply, with a small amount of initial
capital. Marginal trading in an exchange market is quantified in lots. The
term "lot" refers to approximately $100,000, an amount which can be obtained
by putting up as little as 0.5% or $500.
EXAMPLE: You believe that signals in the market are indicating that the
British Pound will go up against the US Dollar. You open 1 lot for buying
the Pound with a 1% margin at the price of 1.49889 and wait for the exchange
rate to climb. At some point in the future, your predictions come true and
you decide to sell. You close the position at 1.5050 and earn 61 pips or
about $405. Thus, on an initial capital investment of $1,000, you have made
over 40% in profits. (Just as an example of how exchange rates change in the
course of a day, an average daily change of the Euro (in Dollars) is about
70 to 100 pips.)
When you decide to close a position, the deposit sum that you originally
made is returned to you and a calculation of your profits or losses is done.
This profit or loss is then credited to your account.
Investment Strategies: Technical Analysis and Fundamental Analysis
The two fundamental strategies in investing in FOREX are Technical Analysis
or Fundamental Analysis. Most small and medium sized investors in financial
markets use Technical Analysis. This technique stems from the assumption
that all information about the market and a particular currency's future
fluctuations is found in the price chain. That is to say, that all factors
which have an effect on the price have already been considered by the market
and are thus reflected in the price. Essentially then, what this type of
investor does is base his/her investments upon three fundamental
suppositions. These are: that the movement of the market considers all
factors, that the movement of prices is purposeful and directly tied to
these events, and that history repeats itself. Someone utilizing technical
analysis looks at the highest and lowest prices of a currency, the prices of
opening and closing, and the volume of transactions. This investor does not
try to outsmart the market, or even predict major long term trends, but
simply looks at what has happened to that currency in the recent past, and
predicts that the small fluctuations will generally continue just as they
have before.
A Fundamental Analysis is one which analyzes the current situations in the
country of the currency, including such things as its economy, its political
situation, and other related rumors. By the numbers, a country's economy
depends on a number of quantifiable measurements such as its Central Bank's
interest rate, the national unemployment level, tax policy and the rate of
inflation. An investor can also anticipate that less quantifiable
occurrences, such as political unrest or transition will also have an effect
on the market. Before basing all predictions on the factors alone, however,
it is important to remember that investors must also keep in mind the
expectations and anticipations of market participants. For just as in any
stock market, the value of a currency is also based in large part on
perceptions of and anticipations about that currency, not solely on its
reality.
Make Money with Currency Trading on FOREX
FOREX investing is one of the most potentially rewarding types of
investments available. While certainly the risk is great, the ability to
conduct marginal trading on FOREX means that potential profits are enormous
relative to initial capital investments. Another benefit of FOREX is that
its size prevents almost all attempts by others to influence the market for
their own gain. So that when investing in foreign currency markets one can
feel quite confident that the investment he or she is making has the same
opportunity for profit as other investors throughout the world. While
investing in FOREX short term requires a certain degree of diligence,
investors who utilize a technical analysis can feel relatively confident
that their own ability to read the daily fluctuations of the currency market
are sufficiently adequate to give them the knowledge necessary to make
informed investments.
Rich McIver is a contributing writer for The Forex Blog: Currency Trading
News ( http://www.forexblog.org ).
