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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.
About The Author
Rich McIver is a contributing writer for The Forex Blog: Currency Trading News http://www.forexblog.org.
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