What Is Forex About?

Foreign currencies can be traded like stocks.
Foreign currencies can be traded like stocks. (Image: Spencer Platt/Getty Images News/Getty Images)

Some of the safest investing techniques take advantage of arbitrage, the practice of using known gaps in price and value between regions in order to make a profit on the difference. When it works, forex -- foreign exchange -- trading engages in arbitrage based on the changing values of different currencies.

Forex Basics

At its simplest, forex trading means buying amounts of foreign currencies and selling them, just as you would shares of stock or some other commodity. You gain a profit by buying a currency at a low value, then selling at a higher value as it grows. Money changing is a simple example of forex trading, one that dates back to biblical times. In the modern world, forex transactions are run via computer, and can be extremely complicated and carefully timed.

Spot Market Trading

The spot market in forex trading is the area where the actual physical currencies are purchased and sold -- such as at a bank, or at the exchange counters in many airports. The proliferation of forex websites has more recently created a second, virtual spot market where users trade foreign currencies much like day traders practiced during the boom in the late 1990s.

Futures and Forwards Markets

The futures and forwards market in foreign exchange trading work something like stock options. Rather than buying or selling currency on the spot, these markets trade in contracts that promise a transaction at a later date. People who feel a currency might drop in value will sell such a contract to mitigate their risk, while people who think the currency will appreciate will buy a contract to seal in a lower price. Analyzing the profitability and risk of forex futures and forwards is complex and risky, an enterprise best left to professionals.

A Zero-Sum Game

One disadvantage of the forex market is that it's a zero-sum game. Stocks can rise in price all together, reflecting a general growth of an expanding economy. To make money in forex trading, a currency must go up in value while another loses value. This means, unlike many other markets, for every winner there will also be a loser. Forex trading is risker than many of the forex websites would lead you to believe.

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