FOREX 101: Make Money with
Currency Trading By
Rich McIver
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
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