What Every Investor Should Know About the Forex (Foreign Currency Exchange) Market
by Jason Dean
In the late 1990s and early part of 2000, it seemed like everybody was making a killing in the stock market. While it was great that lots of people were investing, many were doing so with little or no knowledge of the companies they were buying, or even how the stock market worked! Today it seems that many people are doing the same thing with the forex, a.k.a. the foreign currency exchange market.
Stock-market investing may not be for everyone, but it is for the vast majority of Americans. The forex, on the other hand, is not. This doesn’t mean you shouldn’t try your hand at foreign-currency trading if the idea excites you, but don’t feel fooled by promises of easy money: The forex is the most competitive and cutthroat market in the world, and unlike the stock market, the forex never has a bull market where almost no one can lose — there is a loser on every single forex trade! Who do you think has the advantage, you or the Central Bank of Japan?
First, let’s get some basics down: Unlike the New York Stock Exchange, the forex market does not exist in a physical place — it is entirely electronic. Also, while the U.S. stock and bond markets are open less than eight hours a day, the forex market is global by its very nature, and thus, it is open twenty-four hours a day, five days a week (and a half-day on Saturday).
When you participate in the forex, you use one currency to buy another currency. For example, 122.05 yen may be selling for $1 — this is the “ask” price. Conversely, the “bid” may be 122.00 yen for $1 — in other words, a “market maker” would be willing to pay you 122.00 yen for your $1 U.S. dollar. The difference between the “ask” and the “bid” — in this case, 0.05 yen — is called the “spread.” This is how “market makers” make their money in the forex market, because otherwise, there are no commissions on trades. This is one of the things that makes forex so popular these days.
Another factor in forex’s popularity is the tremendous amount of leverage you’re able to have. For example, for every $1 in your account, you may be able to control $100 — give you 100:1 leverage. Instead of buying 122.05 yen with your $1, you would be able to buy 12,205 yen. This allows you to make large profits on small changes in the value of the currency, but it also can lead to substantial losses. A 1% shift in the value of a currency could allow you to double your money, or lose 100% of your investment!
The forex is not for everybody, and regardless of what the hucksters on late-night infomercials said, it isn’t an “easy” way to make money. Unlike the stock market, the forex is a zero-sum game, meaning you have to be smarter than the person on the other side of the trade in order to make money. A vast amount of education is necessary in order to make sustainable profits, and this article can serve as your initial introduction. But beware: There are numerous forex scams out there. Make sure you really know what you’re doing before you open your first forex account. Good luck!