Tips for getting started in Forex Trading
Ok, so let’s start with the basics; forex stands for foreign exchange, i.e. foreign currency. Forex trading refers to the practice of people trading foreign currencies against each other with a view to making a profit.
Foreign currency values fluctuate in response to various stimuli, such as elections, geopolitical events, and economic activity, meaning that well-informed and analytic traders can use their knowledge of political and economic contexts and understanding of how markets operate to make informed decisions on which currencies are likely to appreciate in value and which are likely to depreciate,
As the foreign exchange market is a global activity conducted in all the world’s major financial centers, the market remains active 24-hours a day for some currencies (we’ll come to this later).
As speculators are stopping trading for the day in east Asia, trading is just getting started in the U.S.A. Due to the reflexivity of currency markets, this means that values are constantly fluctuating.
How do these types of investments work?
All transactions conducted on the forex market involve the buying and selling of two different currencies. The two currencies being traded are known as a currency pair.
Let’s take USD and EUR as an example. This is the most popular (widely-traded) currency pair in forex trading and considered the most liquid, i.e. easiest to trade in for cash. The 2nd most liquid currency pair is USD/ Japanese Yen (JPY).
Let’s say that you have USD and you want to buy EUR. In this case, EUR is your “base” currency while USD is your “quote” currency. A currency pair consists of two currencies, obviously, yet it operates as a single unit: if you purchase the base currency, this automatically implies that you sell the quote currency.
The base currency (in our case EUR) price is referred to as the “bid” price and represents how much of the quote currency (USD) you need to obtain one unit of the base currency.
So, if 1 EUR costs 1.0918 USD, then the bid price in our currency combination is 1.918.
Currencies are priced to four decimal places as even slight fluctuations in the value of a currency can translate into huge gains or losses for speculators trading in large sums of currency
Likewise, when you sell the base currency you receive the quote currency in exchange. In this case, the “ask” price for the currency pair refers to how much you will get in the quote currency for selling one unit of the base currency.
Currency pairs involving USD and another currency widely-traded against USD are known as “major” pairs. Some examples include USD/GBP, USD/CAD, and USD/CHF. These currencies are considered the most-liquid and can be traded 24-hours a day.
Currency pairs that involve currency from emerging markets or from countries with low GDP and market share are considered referred to as “minor” pairs, these are less liquid than the major pairs mentioned above, in the sense that it may be difficult to convert your current assets into hard cash.
A minor pair, however, may still be made up of major currencies, just not USD. Examples of widely-traded minor currency pairs include GBP/EUR, GBP/CHF, and CHF/JPY.
What types of risks exist with these investments?
Forex trading, like any time of financial speculation, entails a degree of risk. This is a crucial factor to take into account when considering speculating on currency markets: the forex market is not very highly regulated, and in some countries is totally deregulated, meaning investors have little protection from the unpredictable and often chaotic behavior of currency markets.
As with any other form of investment, be wise in your speculations, have strategies for managing risk, and only invest what you can afford to lose.
The highest rewards are often also where the highest risks are. It can be tempting to put your money where the most serious gains can be made, but these are also the most unstable currency pairs and a sudden drop in the value of your currency could see you lose a lot of money.
Before making any commitment to investing in forex trading, you should research licensed forex brokers in your country of residence to get a breakdown of what the restrictions and regulations on forex trading are in your home country.
The importance of knowing how to invest in forex
To summarize, forex trading, like any other financial activity, has its pros and cons, its risks and its benefits. One of its main attractions as an investment opportunity is its liquidity. This, however, must be weighed against the risks of putting your money in potentially unregulated markets.
An in-depth knowledge of world geopolitics and global capital flows is also crucial for any successful forex trader. Currency markets are extremely sensitive to all forms of political activity and, in a highly-connected market place such as the currency market, political decisions made in one country may have implications for the value of several, seemingly unconnected currencies. Keep your ear to the ground.
