If you’ve ever traveled abroad, you’ve had to exchange currency.
You can’t expect a French bakery to accept US dollars. So you’d have to exchange your US dollar for a euro. You can’t expect to use a US dollar in Japan. So you’d have to exchange for yen.
Any one that’s done so has participated in what’s known as the Forex market – a market so big it does $4 trillion in volume every single day, as compared to the $22 billion volume done on the NYSE.
To the average investor, that’s just, well… boring.
For the purposes of an introductory lesson with this trading vehicle, let’s keep the explanation as simple to understand as possible, up front.
To a skilled investor, it can build insane wealth simply because of changes in exchange rates. An exchange rate tells an investor how much you have to spend in currency to purchase base currency, or the type of currency you are spending or exchanging. For example, if you want to buy US dollars using yen, you would see an exchange rate such as Yen/USD = 0.0098, which means you’ll spend 0.0098 for one US dollar.
For example, say the US dollar is expected to weaken in value as compared to the euro. A trader in this situation would sell dollars and pick up euros. Then, if the euro strengthens, the purchase power to buy back US dollars has now increased. That would allow a trader to buy even more dollars than initially held, turning a quick profit.
To find profit potential on a currency trade, a trader would refer to what’s known as Pips, or Percentage in Points. Currency pairs such as Yen/USD are quoted with five decimal places with the fourth decimal referred to as the pip. For example, if the Yen/USD appreciated from 0.0098 to 0.0099, the pip climbed by one pip (99-98=1).
When the pip is positive, the trader is in the green. When the pip is in the red, the trader isn’t so happy.
There’s good upside to trading Forex.
Trading never stops. It’s a constant 24-hour a day marathon of activity. Trading costs are typically low with the absence of commission or exchange fees. Liquidity is never an issue with currency. And, traders have international exposure, allowing them to invest anywhere they want.
Don’t get us wrong. There are always downsides. There’s no such thing as a 100% safe investment. In the case of Forex, trading can be very fast and very volatile along the way. Scams exist, unfortunately. And that fact the 24-hour market may move against you when you’re asleep can cause losses as well.
Unless, of course, you’re so well caffeinated that you don’t need to sleep…
Essentially, a trader is just buying one currency while selling another currency, speculating on the rise in valuation given economics, monetary policy, natural disasters, and geopolitical issues. Unlike financial markets, this market has no physical home or exchange. Rather it just trades all the time though businesses, banks, governments, hedge funds, speculators and traders.