Understanding Forex: A Beginner’s Guide
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Looking for new investment opportunities, have some disposable cash, and possess a healthy risk tolerance? Well, currency and currency derivatives trading may be a good fit for you. Investors, large and small, trade currencies and derivatives in a massive global marketplace known as the foreign exchange market (also known as forex or FX).
To understand forex and the opportunities it may present for you, you need first to understand a bit about currency trading.
Say you travel to Japan and need to pay for your food, hotel, and other items while there. You’ll need to exchange your dollars for Japanese yen at a ratio known as the exchange rate. Exchange rates change relative to one another due to central bank manipulation of interest rates, deficits in a country’s current accounts, national debt, and a host of other factors.
Institutions and individual investors speculate on the variations in currency prices by buying (or selling) a currency pair — in this case, USD/JPY — and selling (or buying) the pair when it has moved in the direction they anticipated.
Spot, Forwards, and Futures Trading
To speculate on a currency pair’s short-term or long-term direction, you may trade forex in the spot market. The spot market enables investors to exchange cash for an asset — in this case, a currency pair — at its current market price. The majority of forex activity involves spot market speculation.
However, if you’re looking to hedge your risk, you may trade in the forwards or futures markets. The forwards market allows you to trade contracts to buy or sell currencies on terms you and another investor establish. The futures market, however, involves trading standardized contracts available in public commodities markets.
Investors and corporations with significant international exposure can strategically use forwards and futures contracts to hedge against fluctuations in a currency’s foreign exchange rate.
How Forex Works
Forex is not a centralized market but rather an electronic network of individual and institutional investors, referred to as an over-the-counter (or OTC) market, that is open 24 hours a day, five days a week. However, most forex activity involves trades involving Europe, Canada, Australia, Japan, the U.S., New Zealand, and Switzerland’s currency pairs — markets for which are open during specific times of the day.
Forex trading can be complex and risky. As a beginner, it’s wise not to start with money you cannot afford to lose.
However, by starting small, continuously educating yourself about currency trading, and trusting your instincts, you may be able to make money trading currencies.