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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