What is foreign exchange?
Foreign exchange or forex is traded around the world in a decentralized market based on simultaneously buying one currency and selling another. It is mostly traded in the over-the-counter market where brokers and dealers negotiate directly with each other to determine the relative values of different currencies.
Investors can trade in one of two types of forex markets. Currency futures involve contracts for a specific currency at a set price to be bought or sold at a future date. This is the riskiest of the two forex types and tends to attract speculative investors. Spot forex, involving cash settlements on the spot at current rather than future prices, attracts investors who prefer to buy and hold. Currency futures forex is a regulated market; spot forex is not.
Either way, forex is complex, volatile, and highly risky. Political or economic events and market psychology as well as other factors can all affect currency prices. Success in speculating on how these factors influence a currency’s value requires an expert’s ability to monitor and interpret complex data.
Can anyone invest in this market?
What risks does it have?
It’s important to understand that forex trading is a zero-sum transaction where one party profits and the other loses. More than 70% of the market is speculative. Speculators who buy and sell a currency never plan to hold it and bet on profiting from changes in its market value. Even knowledgeable and experienced traders can suffer significant losses when market conditions change.
There is no central exchange or clearing housefor forex transactions. This means that there is no single exchange rate (price) but many different rates depending on the bank or market maker involved in the trading.
Forex trading with borrowed money is an extremely high-risk way to invest. If your account allows a leverage ratio of 100:1, you can trade $100,000 worth of currency with a deposit of only $1,000. If the currency you purchased goes down by just 1%, you lose your entire $1,000 deposit. If the price continues to drop, you can lose much more than your deposit and end up owing money.
Forex trading is best left to the experts. Forex marketing is very aggressive and aims to make individual investors feel they can be expert forex traders. Seminars and software programs cannot replace the need for research and expert knowledge in forex trading. Don’t be fooled by expensive products that claim to make forex trading and analysis easy for everyone.
Can you sell it easily?
Yes, the foreign exchange market is the largest, most liquid market in the world. It is geographically dispersed and operates 24 hours a day (except weekends).
What are the costs?
Forex agents charge a commission and/or a mark-up in addition to the market price. Dealers or market makers, not retail investors, act as the counterparty in the transaction. They quote a price to the customer who can then decide whether to trade at that price. Forex is a zero sum game—your loss is always the counterparty’s gain.
What are the expected types of returns?
Forex trading results in profits when you sell at a higher price than what you paid.
Trading in the spot forex market has a short timeframe (usually two days), and involves cash. While a trade itself may be profitable, investors can still lose money because of overnight fees, referral fees, and other transaction costs.
Read about forex scams.