The most liquid market in the world is the forex market. Right around $4 trillion changes hands a day in the currency markets, and for those who are willing (and have the financial ability) to stomach the risks that often come with forex trading, it can present a number of interesting opportunities. This is especially true since you can trade forex 24 hours a day from Sunday evening at 5 p.m. Eastern until 5 p.m. Eastern on Friday. And, with the advent of so-called mini forex accounts, it is possible for ordinary people to begin trading currencies.
How the Forex Market Works
The first thing to understand is that you are not actually “buying” and “selling” anything when you “trade” forex. Most forex traders understand that, even though the language used is similar to that used for stock investing, you are actually speculating. When forex trading, you are predicting how one currency will move in relation to another. This means that you can be long on the dollar and short on the dollar — at the same time! It all depends on which currency pairs you are focusing on. If you think the dollar will fall against the euro, but rise against the yen, you can enter both of those positions. And make money on both if you are right.
Currency market transactions are similar to electronic over the counter trading. Many forex traders go through market makers and forex brokers. These organizations provide you with bid-offer set-up. In order to make money, you need to be correct about the way the currencies in question interact with each other — and overcome the spread between the bid price and the offer price. Once you overcome that spread, you usually end up with pure profit. Many forex brokers and market makers make money on the spread, and don’t charge commissions or fees.
When trading forex with a regular account, you usually work with lot sizes of 100,000 units of currency. If you have a mini account, though, the lot sizes are smaller: 10,000. You can make use of leverage to magnify your winnings. Of course, realize, too, that the same leverage that magnifies your earnings if you’re right will also increases your losses if you’re wrong.
Reading a Currency Quote
Before you get started, it is a good idea to understand how to read a currency quote. Let’s use AUD/USD as an example, assuming the current quote is 0.9947. Most currency quotes are done to the fourth decimal place (the yen is an exception, usually only going to two places). The smallest change is a “pip”, or percentage in point. Because you deal with large lot sizes, you can see how a small change in the quote can result in big gains or big losses.
The first currency listed (in our example, the Australian dollar — AUD) is the base currency. This is the currency that is rising or falling. In our example, you can see that AUD is worth less than US$1. It only takes a little more than US$0.99 to make AUD$1. If you are long on AUD/USD, it means that you think the Australian dollar will rise against the U.S. dollar. If you are short on AUD/USD, you think that the Australian dollar will lose in value to the U.S. dollar.
Starting in Forex
It is relatively easy to get started in forex trading. There are many forex brokers and market makers offering their services. You can open a “regular” account, which usually requires at least $2,500 and allows you to control 100,000 units of currency. If you don’t have that much, there are some brokers that offer “mini” forex accounts, often requiring only $250 to start and control 10,000 units. However, it is usually a good idea to open a practice account first. Many forex brokers offer free practice accounts that use current data to help you learn the ropes. These accounts can help you familiarize yourself with the trading platform, and get in some much needed practice before you risk any of your own money. Zecco has a $50,000 Forex practice account you can open for free (click past the landing page to the main site and find the Forex tab).
Disclaimer: I am not a forex trading professional, although I like to dabble with a mini account. Understand that forex trading comes with risks, and you are responsible for your own losses.