Does FOREX Market Guarantee a Minimum Return?
The foreign exchange market, commonly called FOREX, does not guarantee a minimum return to investors. There are many ways to trade foreign currencies, including over-the-counter trading, futures, future options, ETFs, and CD and deposit accounts. There exist a number of government and industry organizations designed to protect investors. None of these protect an investor from a change in the value of his investment.
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Ways to Invest
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There are many ways to trade foreign currencies. Trading in the over-the-counter market through a broker (FOREX trading) is a popular method. Trading futures contracts or options on an exchange is another way. Investors who wish to trade currencies via the stock market can purchase ETFs, or currency options, on the major stock exchanges. Lastly investors can purchase a CD, or open a deposit account, in a foreign currency at a bank.
Misconceptions
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A CD will generate a guaranteed rate of return. Whether the CD is denominated in US dollars or foreign dollars is irrelevant, there will be a return of principle plus interest. The difference in total return (interest plus rate of exchange) is determined by how the foreign currency moves relative to the US dollar. If the foreign currency moves up, the investor gets an added return. If it moves down, a loss in the exchange rate reduces the return.
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Risks
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Fluctuation in currencies can cause an investor to lose money even with a guaranteed rate of return. The value of a currency is affected by a number of events including government policies, economic indicators and balance of trade. The type of investment used for trading can also create added risk. The FOREX and futures markets enable traders to use a great amount of leverage. Though this can result in outstanding returns, it can also cause outstanding losses.
Leverage
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Over-leveraging can force a FOREX or futures trader to close a trade early, resulting in a large loss. The trader can actually lose more than the capital in his entire account. Example, a trader controlling $100,000 with only $1,000 of his own capital, will be forced to close his position if the price moves down one percent. His $1,000 investment is now gone. If the price moves down two percent he will owe the broker $1,000. He lost $2,000 when the investment declined to $98,000, but he only has $1,000 in the account.
Risk Management
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The most prudent approach is to incorporate currency trading as part of a comprehensive portfolio. Avoid using too much leverage. Have a plan of action before making the investment. If the trade reaches a maximum loss, be prepared to close it out immediately. Many government and industry organizations exist to protect investors from fraud, and create greater transparency in the financial markets. A limited amount of coverage is available to shield investors from loss, should a brokerage or bank become insolvent. However, there is no protection against loss from the change in value in any investment.
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