What is Forex and How Does it Work?

Forex is short for the foreign exchange market. Many people make money by investing in the foreign exchange market and so can you. Here’s the basic idea: Currencies fluctuate and you can profit from the daily up and down nature of the market. Let’s say the Japanese Yen is gaining a lot of value — you’ll want to buy a bunch of Yen as it begins it’s upswing and then sell it all when it’s at the peak of its value. All currencies rise and fall. The trick is to buy low and sell high.

The most famous example of success is George Soros who made a billion dollars in one day trading currencies. He’s obviously an outlier, however, as most people see much, much less gains, if anything at all. It’s a risky business, but if you’re dedicated and put in the time to learn the market, there’s money to be made.

XE.com has nice Forex in a nutshell section that lists five benefits to trading the Forex:

  1. Many firms don’t charge commissions – you pay only the bid/ask spreads.
  2. There’s 24 hour trading – you dictate when to trade and how to trade.
  3. You can trade on leverage, but this can magnify potential gains and losses.
  4. You can focus on picking from a few currencies rather than from 5000 stocks.
  5. Forex is accessible – you don’t need a lot of money to get started.

An important point to note is that you are always trading currencies, never buying them. The example with the Yen above was bit oversimplified, but you can’t just buy more money. If this were the case, the richest people in the world would just buy all the valuable currencies and get richer. Instead, if I wanted to get Yen because it was on the rise, I would have to trade in some other currency for it. That’s why in the Forex, currencies are always quoted in pairs, like EUR/USD or USD/JPY. XE.com provides a great example of this:

“The EUR/USD rate represents the number of USD one EUR can buy. If you think the Euro will increase in value against the US Dollar, you buy Euros with US Dollars. If the exchange rate rises, you sell the Euros back, and you cash in your profit.”

As with any market trading, you need to know what you’re doing. Forex trading involves a high risk of loss, and may not be suitable for everyone. If you’re not willing to put in the time to really study the market, it might be best to avoid currency exchanges. If this is something you’re willing to commit to, however, Forex provides great opportunity. As the largest financial market on Earth (yes, even bigger than the New York Stock Exchange) there are so many buyers and sellers that transaction prices are kept low which essentially just means opportunity.

Will you give Forex a try?

Photo Credit: epSos.de via photopin cc

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