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Why the FOREX Market?

Money runs the world. Every transaction that occurs, world wide, involves currency of some sort, so it is no wonder that the trading of currencies is so popular. If you have dabbled in other investment opportunities, you have an advantage over the beginner. Many of the tools and techniques that were helpful in other areas may also be beneficial in the FOREX market as well. We advise that you do your research before jumping into this highly volatile market, however. With great rewards, come great risks!

The History of the FOREX Market

The FX or FOREX market is simply the trading of different countries currencies. Investors from all over the world try to predict the value of government currencies at a later date.

The market has literally exploded in the last 30 years due to changing ideas about currency and the flow of money. The “gold standard” ruled the currency market from 1876 to the beginning of World War I. The premise was simple; currency had a value based on how much gold it was worth. Being backed by gold, gave many economies the ability to thrive and get stronger despite growing inflation problems. With the war came mass destabilization in currency prices world wide. The availability of gold became scarce and with it so did the “gold standard.” The government began to intervene and by the early 1970’s currency was no longer backed by gold and had become more fluid.

The Basics of Trading

Thus the FOREX market was born! Investors just like you, now have the option to make predictions on where the currency market is headed because they are no longer bound by the physical limitations of the “gold standard.” The process begins by choosing 2 different currencies. The first “base currency” is usually U.S. dollars, while the “quote currency” can be anything else.

Every “quote” will have a bid and an ask price. The bid is the price that buyer is willing to buy the “base currency” in exchange for the “quote currency.” This would be like saying that you would be willing to pay $1 dollar U.S. in exchange for $1.5 dollars Canada. You are predicting what the price of the “quote currency” will be at a later date. The “quote” also includes an ask price. This is the price that the buyer is willing to sell the base currency in exchange for the counter currency. To use our example earlier, the ask price could be that you are willing to purchase $1 dollar Canada for $.75 U.S. The difference between the two is considered to be the spread.

A typical trader will probably choose to deal with much more than a few dollars. Calculating your “Pip” is critical in determining the cost of establishing a position. Lets say that the spread for a particular transaction was 134.75 (prices are always quoted using five digits), the last digit which is 5 is known as the “Pip.” This can be used by the investor to ensure that they cover their costs and make a profit on the transaction at a later date.

FOREX Market and the Equity Market Connection

As I mentioned earlier, the FOREX market is very similar to the Equity market in terms of features and vocabulary. The premise behind both trading methods is very similar as well. The goal is to determine what will happen next in the market. Terms such as forwards, futures, options, spread betting, contracts for difference and spot market are all essential to both FOREX market trading and Equity trading. Perhaps the most important term that you will want to become familiar with is margin.

Unlike the equity market which involves a down payment of sorts, currency margins are a bit different. The margin varies by program and transaction, and is basically a guideline for how much money that you are able to make on a particular transaction. In order to cover trading losses, traders in the FOREX market are asked to put a deposit into their account to cover any potential losses prior to a transaction. This amount is determined by the margin. For instance if the margin is 1%, an investor could potentially control $100,000 dollars with only a $1000 dollars up front.

Since most currency trading is based on credit, you will be required to sign a margin agreement when opening up an account. The agreement will outline the credit or margin terms and provides the broker with leverage during the trading process. Discuss with your broker what you are comfortable doing, so that you can have the best possible outcome.

In summary

Seasoned investors are often drawn to the FOREX market due to its known vocabulary and subject matter. The lack of commission charges and high profit factors help sweeten the deal. It is important to note however, that the market is quite different, and there may be an adjustment period. Investing is tricky business, and all investors should become familiar with the risks and benefits, and weigh them appropriately.