As the stock market has been shaky and the U.S. dollar has lost almost unprecedented ground in the past several years, forex trading has reached record levels of popularity.
This is because the forex trading market is one that can never go down (or up, for that matter), and in which the decline of the U.S. dollar has created tremendous opportunities for savvy investors.
What is Forex Trading?
Forex is a term used to mean "foreign exchange." Unlike other markets, the forex market doesn't exist in any physical sense. While stock traders meet on the New York Stock Exchange floor, and bond traders in the Chicago Board of Trade's trading pit, people engaged in trading use telephones and the internet to constitute their market.
Who Participates in Forex Trading?
The biggest money in the world engages in forex trading on a daily basis. This is because national governments and their central banks trade on the forex. You would never find Alan Greenspan trading on the American Stock Exchange floor, but you would find his subordinates in forex - it's a central role for central banks.
In addition to governments and central banks, large commercial banks also engage in forex trading. Multi-national firms perform trading in order to hedge against fluctuations in currency rates. Individual investors try to spot trends in the forex to move in and out of trades at a quick profit.
There are even forex dealers, people and firms whose job it is to buy and sell currency in the forex in order to exchange it in the real world.
The main currencies for forex trading are the euro, the Japanese yen, the English pound sterling, and the U.S. dollar. The Australian dollar and the Swiss franc are also popular.
How Forex Trading Works
Normally, currency is traded for very short periods. A day is about the longest you would want an open currency trade, and most trades are for a few hours, or even a matter of minutes. This is because currency traders typically use massive amounts of financial leverage in their trades which amplifies both the potential rewards and the risks.
For example, to buy $100,000 worth of euros may require a deposit of as little as $1,000. If the euro goes up 1 percent vs. the U.S. dollar, you will have made $1,000 on your investment of just $1,000 - doubling your money.
But what if the euro went down by 3 percent against the U.S. dollar? Not only will you have lost the $1,000 that you risked, but you'll be liable for an additional $2,000 as well.
Making even bigger bets, say $5,000 to control $500,000, could result in catastrophic financial losses. For this reason, it is normally best to make quick trades. In doing so, you will take your trading profits while you can and stop your losses before they become untenable.
The Financial Futures Market - Forex Trading Through Options Contracts
You can also buy options on foreign currency, also known as financial futures. For example, you could purchase a contract for 100,000 Swiss francs to be delivered in six months. During the six months until the contract matures, you have the option to sell the contract.
If the Swiss franc goes up versus the dollar, you could sell the contract to lock in your profits. If the franc declines against the dollar, you could sell your contract early and cut your losses.
Investor Alert - Beware Forex Trading Scams
As the popularity of the forex has increased, so have the number of forex trading scams. Between 2001 and 2006, approximately 23,000 American investors lost $300 million to forex trading scams.
Always be sure that your forex broker is legitimate, and never risk more than you can afford to lose.
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