How Individual Investors Can Profit From Forex Trading
Anyone who buys goods or services while travelling out of the country, in a sense, trades currencies. For example, when a tourist uses an Australian credit card to buy a memento, hotel room or dinner while visiting the United States, the purchase is converted from U.S. dollars into Australian dollars at the prevailing exchange rate. The rate continually changes and so the number of Australian dollars the tourist spends today likely will be different from the amount for the same item tomorrow. Similarly, multinational corporations engage with currency trading online as they purchase goods and services globally. They do so when they pay for goods and services they have received from vendors in another country, to pay staff abroad, or even to buy foreign companies.
Whereas many foreign currency transactions take place every day through such tourist or corporate activity, however, they comprise only one-fifth of all currency transactions. The rest of the transactions come from currency trading by large financial institutions and hedge funds who buy or sell a foreign currency, hoping to score big when the currency moves one way or the other in their favour. Such trading works in a similar way to currency swapping by individuals or companies, except that no goods or services change hands. All trades are computer entries that are netted out depending on the foreign exchange market prices.
Trading Has Moved Online
These days foreign currency trading is no longer the sole bailiwick of the large international players. The rise of the Internet has seen strong growth in currency trading online, which has enabled individual investors to obtain direct market access through Electronic Communication Networks (ECNs). As a result, trading has become accessible to even relatively small individual investors. At the same time, the number of brokers offering currency trading online to these individual investors has sharply increased.
The main purpose in trading foreign currencies is to make money. Some large players profit to the tune of millions of dollars in currency trades. But such trading brings with it major risks. If a currency suddenly turns against the trader and moves markedly in the “wrong” direction, equal amounts of money can be lost. Investors are therefore advised to use the services of a reputable broker who will act as the agent in the transaction and attempt to execute the order according to the trader’s instructions. Advisers suggest investors first set up a “demo” account to see how the system works and what would happen if they were using real money. In this way, too, they will be able to check out the credentials, services and advice offered by the broker. Investors will also want to look to brokers for help in using tools to help reduce the risk in trading and allow them to profit in both rising and falling markets. In addition to trading on the spot market, they might want to use futures, options or betting on spreads, for example.
Few Regulations Exist
No central trading market exists for currency trading online. Brokers can become members of the National Futures Association, which provides arbitration in the event of a dispute. But few regulations exist such as those on a stock exchange. Players can short trades whenever they wish, no rules apply as to how high or how quickly a currency can rise or fall, and there are no limits on how much one person can spend on trading currencies.
Because it is so large, the foreign exchange market is the most accessible and the most liquid in the world. Whereas a buyer may sometimes be prevented from buying a stock because there are no willing sellers, the foreign exchange market is always active and trading is always possible as long as the markets are open. In a sense a trader is buying a whole country as opposed to a single stock in a company. Some traders use fundamental and technical analysis to track the trends in a country to try to determine which way the country’s economy might move and what impact that might have on the currency. Factors such as inflation and interest rates become important determinants.
Trading In Currency Pairs
Whereas on the stock market it is usual to buy shares in one stock, on the foreign exchange market all trading is conducted in pairs, usually expressed in a currency’s standard abbreviation. The first currency in the pair is the base currency. Forex trading Australia between the Australian dollar and the U.S. dollar would be expressed as AUD/USD, for example. Among the major currencies that are traded are EUR/USD (euro-U.S. dollar), USD/JPY (U.S. dollar-Japanese yen), GBP/USD (British pound-U.S. dollar) and USD/CHF (U.S. dollar-Swiss franc). The foreign exchange quotes generally include a bid price, which is the price at which a market maker agrees to buy the base currency, and an ask price, which is the price at which another market maker agrees to sell the currency. The difference between the two is called the spread. Relatively small movements in a currency’s price can lead to big gains or losses. Most currency trading online is conducted in “pips,” which are equivalent to a hundredth of 1 percent. So a bid price might be, say, 1.5162 and the ask price 1.5168. The difference is one of the ways in which the broker makes money. Traders will be expected to pay a margin, or down-payment, up front to cover any losses that might occur. In currency trading online, the system will check the available margin before acting on a trade.
Currency Trading Online Can Be Highly Profitable
Currency trading online, with its availability, accessibility and liquidity, can be highly rewarding, offering opportunities to make large amounts of money as currencies change constantly throughout the day and night. The risks are commensurate, so advisers suggest that you use only money you can afford to lose when trading currencies. Signing up for currency trading online is as easy as signing up to buy and sell stocks. The main difference is that a foreign exchange dealer will likely ask you to sign a margin agreement.