Foreign Exchange Investing 101

The exciting world of Forex trading offers a chance for huge rewards with minimal out-of-pocket costs. Forex trading is an investment strategy where investors earn money by purchasing and selling foreign currency.

The Forex market is open 24 hours a day, 7 days a week, allowing investors to make instant trades. Using leverage, investors control more money than what is in their account. With leverage, investors can make larger trades, which could result in significant earnings.

Such benefits, however, do not come without risks. Investors who do not use their leverage responsibly could end up losing their initial investment and owning their broker money. With proper knowledge, however, there is an opportunity for huge success. Below you will find all the information you need to determine if Forex trading is the right investment strategy for you.

What is Forex trading?

Foreign Exchange trading, more commonly known as Forex trading, is an investment strategy that involves the sale of foreign currency. With Forex (also called FX), investors buy and sell currency from countries around the world, including the following:

  • The United States
  • Japan
  • Switzerland
  • Canada
  • Australia

Investors buy and sell currency in pairs, for example, EUR/USD (Euro/US Dollar) or NZD/USD (New Zealand/US Dollar). The pair represents the value of each currency compared to the other. So, with FX, investors buy one currency in the pair and sell the other currency in the pair. In the EUR/USD example, a broker might quote it as 1.5000. What this means is that it takes $1.50 to buy one euro.

So, how does an investor make money with Forex trading? Each currency has an interest rate attached to it. The interest rate is assigned by the country’s central bank, much like the Federal Reserve in the U.S. When making trades, investors must pay interest on the currency they are selling. They make money by collecting interest on the currency they buy.

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Common Forex Terms

There is a great deal of terminology associated with Forex trading, and investors must understand each to be successful. The following represents the basic terms needed to get started with Forex trading:

  • Currency Pair – Brokers quote currencies in pairs (EUR/USD). The first currency listed represents the base currency and the second represents the quote currency. The pair represents how much of the quote currency is needed to purchase the base currency.
  • Yield – The income investors receive on an investment is known as yield.
  • Leverage – Brokers allow investors to borrow money to make trades. This borrowed money is known as leverage. The benefit of leverage is that it enables investors to make more trades than what they could make with the actual value in their account.
  • Carry Trade – Investors sometimes use the strategy of buying currency at a low-interest rate and using the funds to buy currency with a higher interest rate. The idea is to earn money on the interest difference between the two countries.
  • Liquidity – The term liquidity refers to how easily a currency pair can be exchanged without affecting the price of the pair. The FX market is available 24 hours a day, 7 days a week, which makes investments in FX highly liquid.

Why is Forex trading so popular?

Investors can get started in FX trading with a small investment, usually less than $100. With leverage, investors can borrow additional money from their broker. As a result, investors can control a large amount of money despite the actual cash value in their account. Thus, there is potential for tremendous earnings with only a small out-of-pocket investment. Further, most brokers provide trading software that makes trading easy. That, with the abundance of free tutorials available online, just about anyone can be successful.

The currency market is open 24 hours a day, 7 days a week, unlike the stock market. The high availability is appealing to investors who have the skill to stay up-to-date on economic trends throughout the day. If they see something that would work to their advantage, they can react quickly without having to wait until the market reopens.

Risks of Forex Trading

Although Forex trading can have great rewards, it also has the potential for significant losses. Investors who don’t use leverage wisely could lose the money in their account and end up owing their broker money. There are ways to minimize this risk using stop-loss features in your broker’s trading software. However, an investor must understand the tools to use them correctly.

When it comes to trading, there are a lot of terms that an investor must understand. Without a solid understanding of the terms, they may not understand the details of their trades and as a result, make costly mistakes.

How to Get Started with Forex Trading

Many of the large brokerage firms offer Forex trading accounts with very little investment required. You can often open an account online. Open your account with the minimum investment determined by your broker. Stick to investing using only this amount in the beginning. Avoid using leverage until you fully understand how FX trading works.

Before making your first trade, take time to read through any training material on your broker’s website. They often provide a wealth of training material on the basics of FX trading. Also, be sure to look online and read as many tutorials as you can on the subject. Make sure you understand everything before you make your first trade.

Another crucial step in getting started is following your broker’s tutorials on how to use their trading software. You will need to understand how to make your trade, how to use leverage and what tools are available to minimize your risk. It is your responsibility to know how the system works so that you are prepared to trade with confidence. Brokers expect you to understand how to use the system and will not correct errors you may make due to a lack of understanding. If you have questions, it is best to call your broker and get details before you proceed with any trades. This will allow you to avoid making costly mistakes.

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