Investors looking for a fast paced market will feel right at home in currency trading. Forex markets operate 24 hours a day, five days a week. In fact, forex is the largest investment market in the world, with billions of contracts traded daily. And, unlike the stock markets which have thousands of listed securities, most of the currency trading takes place between around 20 pairs of global currencies.
There are many enticing reasons for investing in forex. For starters, the high liquidity of the market provides more trading opportunities. Transaction costs are also very low even for retail traders. Retail traders also have access to leverage, which gives them much more purchasing power in the forex markets than they otherwise would have. All of this and it’s easy to see why forex is a non-stop market.
For beginners interested in forex, it helps to understand what you are getting into. While relatively straightforward, there are nuances traders should understand. Let this be your basic guide to forex trading.
What is currency trading?
Currency trading is often referred to as forex (foreign exchange). Therefore, currency trading does not take place on a regulated trade like stocks or commodities. Instead, it takes place on a self-regulated global exchange, between buyers and sellers of currencies.
Those who participate in forex can trade currency pairs. Every transaction in the forex market involves two currencies, or the difference in value between those currencies. The base currency and the quote currency form an exchange rate: the amount you pay to convert the currency. Because the forex market is volatile, these rates change often.
The goal of forex trading is to take advantage of the relationships between currency pairs to achieve returns over time. Traders “buy the pair” if they think the base currency will get stronger. Conversely, they will “sell the pair short” if they think the base currency is going to fall. Currencies are quoted with four decimal places, called pips. Traders monitor the bid-ask spread of currency pairs and trade based on changes in pips.
How does the Forex market work?
Forex is self-regulated by buyers, sellers and traders of currencies. While the volume of transactions and the size of trade are the main drivers of liquidity in the market, there are many global factors that affect the prices of the currencies themselves. For example, some of the most important are:
- Economic instability in countries
- Political or monetary policy
- Interest rate and inflation
- GDP, including imports and exports
These factors influence the value of currencies against the others with which they are associated. For example, if a country lowers its interest rates and increases its imports, the value of its currency is likely to increase. This opens the door to specific types of forex trading, such as currency carry transactions.
Currency as an asset
When you trade forex, you are not actually converting USD to JPY or GBP. Instead, forex is purely speculative. You trade the volatility of the relationship between two currency pairs.
Take EUR / USD for example. If the United States appears to be heading into a recession, you can go long in betting that the exchange rate could move further in favor of the euro. If so, your return is equal to the change in the investment against the pip in the bid-ask quote. This is all happening on the computer – you haven’t actually moved any change. It’s all about credit contracts.
Most retail traders trade micro and mini lots. This is representative of 1,000 and 10,000 lots of base currency.
The advantages of Forex trading
Forex trading enjoys great liquidity. With nearly 24 hours of trading, five days a week, and a low average time to trade, forex is the most liquid investment market in the world. There are trillions traded daily and constant fluctuations in bid-ask prices. This means that there is always an opportunity for traders. This availability is also an advantage, since traders can trade at will.
While no regulation looks like a downside, it’s actually a big plus for forex traders. A decentralized market is immune to disruptions and surprises. There is also an inherent stability in trading something as big as money. Unlike a stock, which can lose value because of bad news, currencies are much more stable. A move of more than a few pips is rare.
Leverage is also easier to obtain in the forex market. Traders are not limited to FINRA’s fairness standards. It’s easy to leverage micro and mini lots into powerful buying opportunities. And, there are plenty of volatility within major currency pairs to support all types of trading around the clock.
Risks associated with currency trading
Currency trading is often dominated by brokers. This means that there is a lack of transparency for retail traders. Retail traders may not get the best prices or have their orders filled the way they want. That said, there are regulations that brokers must follow. Even in an unregulated market, the broker Actions are still subject to financial regulation.
The other problem faced by many new forex traders is the risk of leverage. Forex markets operate with a leverage of 50: 1. While this amplifies purchasing power, it can also open traders to larger losses and more risk. Capital allocation is an essential skill. And risk management is essential. This, coupled with high volatility in global markets, can be a shocking introduction to currency trading.
The bottom line
Trading currencies in the forex market is a great way to get involved in investing. The simplified and straightforward concept of currency pair trading is easy for beginners to understand. In addition, its high liquidity and leverage capacity make it perfect for retail investors.
Speculators and technical investors will find their place in forex. The volatility associated with this market offers opportunities for everyone. And, with 24-hour transactions available five days a week, business activity is constant.
And you can build a rich lifestyle by investing in foreign currency. To learn more, sign up for the Liberty Through Wealth email newsletter below. This FREE newsletter will help you discover the latest wealth building strategies and investment opportunities.
Forex moves quickly, which can scare new investors off. The advantage is that it is easy to learn in real time. Ultimately, this speed becomes an asset. And, because there are no insiders in the forex market, anyone can be successful if they take the time to learn.