What is forex investing?

Forex is a portmanteau of the words “foreign exchange,” which refers to the market that determines the exchange rates for foreign currencies. Forex trading refers to when a trader buys and sells currencies to take advantage of differences in exchange rates. But going to your local bank branch and buying euros for your upcoming summer vacation is not forex trading – developing trading strategies that speculate on the price movement of a foreign currency relative to others is what forex traders do.

The foreign exchange market is one of the largest, most liquid financial markets in the world, with an average daily trading volume in the trillions. The vast majority of forex trades are conducted by institutions like private banks and hedge funds, or nations’ central banks and national treasuries. Individuals can also trade currencies over the counter (OTC) if they have a brokerage account that supports forex trading.

National currencies are given a three-letter code, similar to a company’s stock ticker. For example, the U.S. dollar is USD, while the single currency of the Eurozone, the euro, is EUR. Currencies are always traded in pairs, like the euro-U.S. dollar represented as EUR/USD. Generally, the base currency in the trade (i.e., the one being actively bought or sold) against the other is listed first.

What is the forex market?

The forex market operates 24 hours a day, five days a week, Monday through Friday. Unlike other financial markets, the forex market does not have a central exchange, like the New York Stock Exchange or the London Stock Exchange. Instead, it operates through a network of banks, brokers and other financial institutions that trade currencies electronically OTC.

The main players in the forex market are central banks, commercial banks, hedge funds, investment firms and retail traders. These participants trade currencies for a variety of reasons, such as to facilitate international trade, to hedge against currency risk, to speculate on currency movements or to invest in foreign currencies. Currency prices in the forex market are influenced by a variety of factors, including economic reports, political events, central bank policies and market sentiment.

The basics of forex trading

Forex trading is conducted electronically OTC, meaning that trades are made between two parties without the need for a central exchange. Instead, a network of banks, brokers and other financial institutions facilitate trades around the clock, five days a week. For an individual to trade forex, they must first open a brokerage account that supports forex trading.

Forex trading in the U.S. is regulated by several government agencies at both the federal and state levels. The primary federal regulatory agency for forex trading is the Commodity Futures Trading Commission (CFTC), which oversees the forex market and enforces rules and regulations to protect investors. Additionally, forex trading in the U.S. is also regulated by the National Futures Association (NFA), which is a self-regulatory organization that is overseen by the CFTC. The NFA is responsible for enforcing ethical and professional standards for forex brokers and other futures market participants.

Forex brokers in the U.S. are required to register with the CFTC and become members of the NFA. Forex brokers outside the U.S. may not be regulated to the same extent as domestic brokers, which means they may allow for greater risk and the potential of greater losses.

While it isn’t necessary to trade forex, leverage allows investors to trade more capital through their brokerage firm, with some leverage ratios being as high as 1:50. In short, leverage increases your buying power as an investor. The reason many brokerage firms offer such high leverage ratios is because forex price changes are significantly smaller than, say, stocks. While stock prices can swing massively in a single day, most foreign currencies don’t move even close to this much daily. However, it’s important to remember that leverage not only amplifies your potential for gains, but losses as well.

Traders use a range of tools and techniques, such as technical and fundamental analysis, to analyze the market and make trading decisions. For example, companies can leverage currency strength when purchasing raw materials or products overseas with these tools when trading forex.

Keep in mind, though, that forex trading requires a relatively high level of investment knowledge and experience, and is not recommended for novice investors. What’s more, there may be other factors than the ones listed below that influence forex trading, and all investors are encouraged to do their due diligence before doing any trades.

Factors important to forex trading

Forex trades can be influenced by a variety of factors, including:

It is important to note that currency values can be influenced by a complex combination of the above factors. And unlike other markets, because there are two sides to every currency pair, it’s often how the factors above evolve in one jurisdiction relative to another that determines the success of a forex trade – or lack thereof. Some very famous forex trades have earned large profits, but the volatility and complexity of forex trading can lead to large losses for traders who lack a clear plan to mitigate them. For this reason, novice investors are cautioned to stay away from forex trading.

However, more advanced investors may use futures and options contracts in forex trading to hedge against currency risk or to speculate on currency price movements without actually physically exchanging currencies in the market. Another potential advantage of forex trading is that companies can use it as a way to leverage currency strength when purchasing raw materials or products overseas.

The bottom line

For individuals who have a solid understanding of macroeconomics and global markets, forex investing can allow investors to realize profits as long as they keep in mind the risks. Consider discussing your goals with a financial advisor to see if forex trading is appropriate for your investment strategy.

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