Foreign currency trading is the buying (going long) or selling (going short) of foreign currencies. It can be as simple as changing some money for a holiday or paying for goods delivered from another country. The difference between the ‘long’ and ‘short’ prices is known as the ‘spread’. Forex prices are always changing as the values of the currencies change in relation to one another.
The foreign exchange (forex) markets are the largest financial markets in the world, with an average daily turnover of US$1 trillion. 90-95% of foreign currency trading is speculative – investors trading currencies in the hope of making a profit as the exchange rates fluctuate.
Currencies are offered in pairs, for example US dollars and Euros or US dollars and Yen. The major currencies are US dollars, Yen, Euros, Pound sterling, Swiss Franc, Canadian dollar and Australian dollar. Around 85% of transactions involve these currencies.
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Forex trading strategies
There are two major forex trading strategies. Forex day trading is where you hold a currency for a day or less and try to make money on the short-term price fluctuations that occur over a day. This is the riskiest strategy but also holds out the promise of the biggest rewards – and losses.
Other investors take a longer view and hold currencies for longer periods. They hope to make money by predicting changes in the fundamental value of the currency.
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How to leverage your capital for maximum profits
Unlike the stock markets, foreign exchanges let you make trades that are several times the size of the balance in your trading account. This means you can make big profits on your trades.
If you have US$1,000 you could ‘leverage’ that to trade up to 200 times that amount. This means you could be trading up to US$200,000 at a time. This means you are taking the profits from much bigger trades than you might otherwise be able to afford.
Here’s an example:
Without leverage: You have US$1,000. You spend it all on Euros. The price rises by 5% and you make US$50 profit.
With leverage: You have US$1,000. You leverage your US$1,000 by 10 times and spend US$10,000 on Euros. The price rises by 5% and you make US$500 profit.
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Reducing your risk
Of course, when your potential profits get bigger, your potential losses get bigger too. Our expert money manager uses an average leverage of between three and six times the balance in your trading account and prevers not to go above 10 to one. This gives you the benefits of leveraging your funds but reduces the risk of making big losses.
Our broker AC-Markets offers a margin watching service for your added protection. This means that if your losses reach 99% of the balance in your trading account, they will automatically sell and stop your losses. Most banks and brokers will let you continue to lose money, meaning that you can end up owing lots of money to cover your losses.
Find out more about AC-markets’ margin watching service here.
How Does Forex Trading Work?
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The forex markets
Trading takes places 24 hours a day on markets all around the world. Unlike stocks and shares, there is no central exchange. Forex is traded constantly through a network of banks, corporations and individual traders all around the world. London is the biggest geographic trading centre around the world, with 31% of global trade (followed by the USA on 18% and Japan at 8%).
The week begins on Monday morning in Wellington, New Zealand, then moves to Australia, Asia, Europe and finally the USA. New electronic foreign currency trading platforms allow investors to take part in online forex trading on any of these markets in real time, at any hour of the night or day.
Some of the advantages of the forex markets:
- No commissions
- Small, transparent spreads
- Quick execution of trades
- Lower trading costs than most other markets.
If you would like to read more about this subject, please click on the links below.
About the forex market
Origins of forex
Market participants
Main forex markets
Market dynamics
Speculation vs investment
Calculation profit and loss
Margin trading
Order types
Trading examples
Trading with a strategy
