Currency Trading for Novices
As of 2007, an average of more than $3 trillion in currencies was being traded every business day. That makes currency trading (also known as Forex trading) the largest market in the world. The currency market exists so businesses, governments and individuals can exchange one currency for another to carry out transactions in other countries. But that's only about 20 percent of the currency market. The rest is trading by speculators, ranging from giant hedge funds to individuals trading from their PC at home, all seeking to make a profit off fluctuations in currency exchange and interest rates.
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Identification
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The Forex market is a global network of banks and financial institutions, rather than a specific trading venue like a stock exchange. Nearly all trades are in purely electronic form, with no exchange of physical currency. This allows Forex trading to continue 24 hours a day (5 days a week). The currency trader executes transactions with a dealer (usually called a broker). With the appearance of the Internet, currency trading is now almost entirely online and has grown enormously in volume.
Types
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The essence of currency exchange is simple: When you travel, you have to exchange your money for the local currency. For example, in Europe you'll exchange U.S. dollars for Euros at the current exchange rate before you go shopping. This is the most familiar type of currency trade to most people. The currency trader exchanges currencies in hopes of making a profit from variations in the exchange rate or differences in short-term interest rates.
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Features
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Currencies are traded in pairs, each with its own exchange rate. The largest volume pair is the Euro/US dollar. You'll see this listed as EUR/USD followed by the exchange rate, which might be a number like 1.3221--meaning it takes 1.3221 dollars to buy 1 Euro. The smallest increment by which a given pair can change by is called the pip. For the EUR/USD, that's 0.0001, or 1/100 percent. In any transaction, the buyer will make an offer ("bid") and the seller a counter offer ("ask"). For currency wholesalers, the bid/ask spread is 1 to 2 pips. When you trade a currency, your broker marks the spread up to 3 to 20 pips (this is how the broker makes his money). If you later close out the transaction at an exchange rate that exceeds the spread, you make a profit.
Function
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The potential for large profits (and the high risk of Forex currency trading) lies in the fact that trades are done on margin. You only put a small portion of the money down to secure a large amount of currency. (The amount you must have is called the margin requirement.) As a result, even a very small change in currency rates can yield a handsome profit. You need to have a good broker. Choose a reputable Forex broker who is a member of the National Futures Association (the self-regulating body for Forex dealers in the United States). You'll want a broker who offers real-time quotes online, and access to a good trading platform (software) if you don't have your own. Compare fees as well; the pips brokers charge in Forex trading are not regulated by the SEC, and some are much higher than others.
Considerations
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Currency trading can be very profitable, but it is a speculative and high-risk form of trading. To trade successfully, start by learning how macroeconomic factors like national monetary policy, trade policy and news events affect exchange rates. In addition to these fundamentals, you need a good grasp of the technical aspects--how to read and interpret price charts, for example. A key to profitable currency trading is management of not just your money but yourself. Learn and use strategies to reduce risk, and how to make trading decisions calmly and rationally.
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