‘Forex’ is the name given to trading in foreign exchange in an attempt to make a profit from changes in currency exchange rates.
When a currency rises in value, it is said to be ‘strong’. When its value falls, it is ‘weak’. A typical forex trade involves using a strong currency to buy a weaker currency.
At some future point when the weaker currency has recovered some of its strength, you can exchange it back or use it to buy a different weak currency.
The gains made on each subsequent trade add up to hopefully provide you with an income that you can spend or reinvest.
Perceptions of forex
There are several commonly held perceptions of forex and how it compares to other methods of investing:
• It is volatile.
• It is high risk.
• It takes a long time.
While this is all true to an extent, like any investment there are ways to adopt a sensible approach to forex and reduce your exposure to the volatility.
Like other investments, long-term forex investment is more likely to yield larger returns because you can reinvest your short-term gains.
But you can also make significant returns on short-term swings in currency exchange rates, if you’re able to spot the currency pairs that have deviated furthest from their long-term value.
Things to remember
Remember that forex doesn’t just mean converting from your own currency. It’s easy to become fixated on exchange rates with your domestic currency, but there might be value to be found from exchanging between two foreign currencies.
Some of the most popular currencies to exchange in forex trades include pounds sterling, the US dollar, euros, Canadian dollars and Japanese yen.
To exchange between two foreign currencies, you’ll first need to hold one of those currencies.
Because of this if you plan to invest in forex over the long term, it can be sensible to spread your money across several currencies so you can benefit from increasing strength of any one currency, without being restricted by how well your own domestic currency is doing.
What factors affect forex?
Foreign exchange rates can be affected by a fairly broad range of influences, especially including economic and political factors.
A country with a strong economy will typically have a stronger currency, while a country in recession is likely to have a weaker exchange rate than usual.
Political upheavals can also weaken a nation’s currency, whether they are extreme events like military coups and civil wars, or simply an unexpected election result.
Remember investors generally like stability, so anything that makes one country’s economy less certain is likely to be met by investors moving their funds elsewhere, which in turn can weaken that nation’s currency.
Because of this, to make a fully informed decision about forex trading, you need to keep on top of financial results, GDP, central bank base rate decisions, political procedures and reports of civil unrest.
Glossary of terms
There are a few terms you’ll hear in relation to forex trading, including:
• Ask Price: The price a buyer is willing to pay for a particular currency.
• Base Currency: The currency you hold (i.e. the currency you want to exchange from).
• Bid Price: The price a trader is willing to accept to sell a particular currency.
• Quote Currency: The currency you want to buy.
• Spread: The difference between the ask and bid prices. Generally a smaller spread indicates better liquidity.
There are many more words and phrases used in forex trading but these five are among the most important and together they define the currencies, prices and liquidity of any given trade.
About forex brokers
A forex broker can provide the services you need to trade in foreign currencies and to make sure your trades go through at the correct prices.
Choosing your broker is the first step, so take your time and find a reputable broker that offers the services you need and has good ratings from previous clients.
Once you find a broker you like, you should start to build a relationship over the course of subsequent trades.
You can switch to a different broker if you’re not happy with the service you receive, but once you find a broker you can work with, they can be a valuable ally for future forex trading.
Moving on with forex trading
Once you’re familiar with the terminology and the basics of forex trading, you’ve decided which currencies to start with, and you’ve found a broker, you’re ready to progress with your investing.
Keep a close eye on the currencies you buy so you know when to trade back at a profit, or when to make a further trade into a third currency if that will make gains.
Start to spread your money among several of the stronger currencies and you’ll be in a position to capitalise on relative strengths and weaknesses in different currency pairs other than your own domestic currency.
Build your gains over time and be watchful for any signs of a strong currency weakening, so you can make sure to sell while it is still high and buy back in at a weaker point, effectively making a gain even on a currency that is falling in value.
Disclaimer: The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.