Help With FOREX
FOREX, also called FX, is the virtual online worldwide market for the global exchange of currencies. It is the largest market in the world, in terms of the dollar amounts traded on the market, and the only market to function 24 hours a day, to reflect the global nature of currency transactions. As the famous country song sings, "it's five o'clock somewhere." The FOREX market is characterized by large amounts of leverage, volatility and its sheer size and liquidity.
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Currency Trading Versus Debt and Equity
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The first thing to remember about owning currency is that it only reflects a store of wealth; it does not generate it. Currency represents no interest or ownership in a company, and does not inherently contain wealth. There are no earnings, and so currency pays no dividend or interest payments. All currency investing is therefore speculative: Your investment thesis is simply that someone, someday in the future, will pay more for that quantity of Japanese Yen than you paid for it yesterday -- or, alternatively, that you fear the dollar will fall.
Use Currency as a Hedge
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Typically, professional traders tend to use currency investing as a hedge against price fluctuations, rather than as a vehicle for growth in its own right. For example, a farmer planning to sell wheat to a European market might purchase a contract that gives him the right to exchange Euros for dollars at today's rates. When he does, he is protecting himself from a sudden decline in the Euro against the dollar, which would hurt him in the pocketbook if he gets paid in Euros. Although the hedging approach is extremely common, a number of large hedge funds use currencies as an investment in their own rite, seeking to take advantage of inflationary pressures or deflationary pressures in other countries.
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Use Leverage With Caution
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Many traders use large amounts of borrowed money, typically a margin loan from their FOREX broker, to magnify their potential returns. For example, if you have an account with $10,000 invested, a 10 percent rise gets you an additional $1,000. But if you have borrowed another $10,000, a 10 percent rise nets you $20,000 (minus transaction and interest costs). But leverage cuts the other way, too: A 10 percent loss in this case would cost you $2,000, or 20 percent of the amount you invested. FOREX traders can frequently leverage up to 100 to one. That is, for every dollar you have invested, your broker may allow you to borrow up to $100. With leverage, you can potentially lose more money than you have invested. Leverage is a useful tool to magnify the small price fluctuations typical in the FOREX market, but it is not for the faint of heart or for the novice investor.
Master the Basic Trades
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While there are scores of currencies on the FOREX market, there are only a few basic trade structures. You should thoroughly understand each of them. The basic transactions are spots transactions, which are pure currency exchanges within a two-day period; a forward transaction, which is an agreement to make the trade at an agreed-upon price at some point in the future; a swap, in which the exchange is made with an agreement to trade currencies back at some predetermined point at some future point.
Don't Neglect Transaction Costs
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When you make a FOREX trade, you don't pay a commission in a traditional sense. Instead, the brokers keep a small portion of each transaction, called the spread. You also pay interest on any margin borrowing you do.
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