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In reality, you don’t even have to be a currency trader to participate in the online Forex trading market. The Forex market is huge. In fact, if you’ve ever traveled overseas and exchanged your money into another currency you have participated in the foreign exchange market. 

According to a 2007 Survey of Foreign Exchange and Derivative Market Activity by the Bank for International Settlements, the currency trading market generates about $3.2 trillion dollars worth of transactions a day. It is this incredible size that makes the Forex market the big dog of finance. The Forex market dwarfs all other capital markets in its world!

Don’t let the market’s overwhelming size scare you though, because when it comes to trading currencies, the basic concepts are quite simple. In this article we’ll provide some basic Forex trading education and examine some of the concepts that any Forex investor needs to understand.

Why Yield Drives Your Return

One thing to remember when it comes to trading currency is that yield drives return.

You see, when you trade the foreign exchange market you are really just buying and selling two underlying paired currencies. You’ll notice that all currencies are typically quoted in pairs because each currency is valued in relation to another currency. As an example, if the USD/JPY pair is quoted as 105.38 that means it takes $1.00 to purchase one 105.38 Japanese Yen.

Since, in every currency trade, you are simultaneously buying one currency and selling another you are basically using the proceeds from the currency you sold to purchase the currency you are buying. The difference is you profit.

The Eight Major Currency Pairs

Another great thing about the Forex market is that it isn’t like the stock or equities markets. By that I mean that where investors have thousands of stocks or equities to choose from, in the currency market you really only need to follow eight major currencies.

By following the news related to their economies you can determine which will provide the best short (sell) or long (buy) opportunities. These following eight currencies make up the majority of trades in the currency trading market:

1. USD - United States
2. EUR - Euro
3. JPY - Japan
4. GBP - United Kingdom
5. CHF - Switzerland
6. CAD - Canada
7. AUD - Australia
8. NZD - New Zealand

These currencies are considered the majors because their countries, by and large, have the largest or most sophisticated financial markets in the world today. 

Economic data is released from these countries on an almost daily basis, which allows an investor to stay on top of the market. This continuous availability of news is vital for assessing the health of each countries economy and the future direction of it’s currency in a timely manner. This has made online Forex trading  one of the most accessible ways to actively invest available today.

Big Leverage – Risk vs. Returns

Another advantage of the currency market is that it offers an investor tremendous leverage compared to the stock market. It is not uncommon to find ratios of 100:1 which allows you to control $10,000 worth of the underlying currency or assets with as little as $100 of invested capital. 

But trader beware, with great power  comes great responsibility, because leverage is a double-edged sword. One of the dangers of currency trading, high leverage can create huge profits, in relation to the amount of invested capital, when your trade goes as planned - it may also generate a huge loss if you’re wrong.

Obviously leverage needs to be used cautiously, but even with relatively conservative leverage of only 10:1, a 5% yield on a currency pair position would translate into a 50% rate of return on an annualized basis if you use a longer-term or "carry trade" strategy.

Remember leverage basically amplifies any market movements. Bigger ups, and also bigger downs. Losses however can be limited by using stops. On top of that most brokers will offer some form of  margin monitoring, This means that your position automatically liquidates once your margin requirements exceed your account balance. So your account won’t post a negative balance and your risk is therefore limited to the money in your account.

Carry Trades

As mentioned above, traders developed one of the most popular long-term Forex trading strategies around, the carry trade, to take advantage of the fact that currency values never remain fixed. Carry traders look to earn not only the interest rate difference between the two currencies in the pairing, but they also hope their positions will appreciate in value over the time they are held. 

How Do Interest Rates Factor In

It is important to know where interest rates for your currency pairs are going in currency trading. You should have a good understanding of the underlying economics  and monetary policies of the country in question. 

For instance, countries with strong growth that are performing well economically but have increasing inflation may raise interest rates to control the inflation.

Conversely, countries facing slow growth and tough economic conditions or even recession might consider reducing interest rates.

Access Is Everything

In addition to the large market size and small number of currencies to track, one of the biggest advantages of learning to trade in the Forex market is the ease of access to online trading systems and market information. 

The widespread availability of these electronic trading networks means that Forex trading is now more accessible than it has ever been. And unlike stocks, the likelihood that one of the eight majors currencies could go to zero value is far less likely than it is for a company no matter how large that is without the sovereign resources of a nation state. 

It’s Easy To Get Started

For as little as a few thousand dollars you can get started trading currency. The largest financial market in the world offers a wonderful opportunity for investors who make the effort to seek out a proven and tested trading methodology and Forex training from an experienced trader.

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This entry was posted on Wednesday, June 11th, 2008 at 3:29 pm and is filed under Making money. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.