Currency Trading for Beginners
Since the 1980s trading on the foreign currency market (often called the Forex market for short) has grown from a daily volume of $70 billion to an average of $3.2 trillion each business day in 2007. This growth was the result of the advent of the Internet and electronic funds transfer that opened the market to traders both large and small. For the beginner it's vital to learn the basics because this is an unregulated and highly speculative market that carries high risks along with the potential for high profits.
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Identification
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If you take a vacation in another country, you'll go to a bank or currency dealer and exchange your dollars for the local currency (minus a small transaction fee). That is essentially what happens on the world currency market on a much larger scale. About 20 percent of the transactions consist of currency exchanges that are part of international business operations. The remaining 80 percent is speculative trading by traders ranging in size from individuals trading from their personal computer to large hedge funds and other financial institutions. Because there is no physical exchange of currency, trading is fast-paced and continues 24 hours a day every business day.
Types
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Each currency has its own value relative to others. Currencies are always traded in pairs. That relative value (called the exchange rate) constantly fluctuates in response to market conditions. For example, the most widely traded pair is the Euro and the U.S. dollar. Using the standard notation, this will be quoted as EUR/USD = 1.4325, meaning that at the quoted exchange rate it takes $1.4325 to buy one Euro.
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Features
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To understand how a currency trade works you first need to know what a pip is and the role it plays. The pip (percentage in point) is the smallest increment by which an exchange rate can change. In the EUR/USD example, the rate could change from $1.4325 to $1.4326, so the pip is $0.0001 (1/100 U.S. cent). To make a trade, a buyer makes a bid and a seller states an asking price. The spread (difference) between bid and ask prices is usually only one to two pips for wholesalers. Retail currency dealers mark this up to three to 20 pips and keep the difference instead of charging a commission on the transaction.
Function
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The goal of the currency trader is simple: guess which way the currency exchange rate will move. If you guess right and the change is greater than the spread, you make a profit. What makes Forex trading so profitable---and so risky---is that these trades are made with extremely low margin requirements. The ratio of margin funds required to currency bought can be up to 400:1, meaning you can put just $250 down to "buy" a lot of $100,000 worth of a foreign currency. Even the tiniest change becomes important and can spell the difference between a large profit or losing all of the margin funds you put up.
Considerations
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Before you begin trading, educate yourself about the Forex market. Learn how macroeconomic factors such as monetary policy affect exchange rates. Study how to read price charts and interpret market trends, what trading strategies work, and how to control risk. Remember, this is an unregulated market. Choose a dealer who is a member of a self-regulating organization such as the National Futures Association. Finally, be sure to choose a broker/dealer who provides real-time rate quotes, offers good trade execution software online and charges a reasonable price.
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