Introduction to Forex Investing

Foreign exchange trading, also called forex or FX, is one of the most popular forms of trading around the world. The idea of forex is simply to trade one currency for another, in hopes that its value will rise and you can in turn make a profit. If you have ever travelled out of the country and exchanged your home currency for the local currency, this is essentially what forex traders do. They just do it from their computer and in currencies all around the world. Successful foreign exchange trading is very difficult, and having a good grasp on the basics is the only way to start. Begin trading without a solid foundation and your finances will soon crumble. Simply understanding forex is one of the biggest obstacles to making profitable trades. For this reason, among many others, forex is considered to be a risky investment and should not be attempted by inexperienced traders.

Reading Forex Quotes

Let’s start with reading a basic forex quote, which may look something like the sample below.

Forex Quote

To start, we see currency pairs in the column labelled “Currency”. Each pair contains a base currency, which comes first, and a counter currency. In these examples, the base currencies are the euro and the pound, while the counter currencies are the US dollar and the Japanese yen. The base currency is always seen as a unit of 1, while the counter currency is quoted. We will look at examples to clarify this later in the article.

How Forex Works

As mentioned, currency exchange when travelling is one of the most common forms of foreign exchange. Although it is not necessarily done for profit, the premise is the same. When you trade your currency at an airport or a local bank, you may notice that they will have different prices for whether you are buying or selling a given currency. Also, the exchange rates change very often, so an exchange one day may yield more or less than an exchange for the same amount the very next day. It may sound a bit confusing, and to be honest, it is at first.

The difference in price when buying and selling at a local currency exchange is the same as the bid and ask in the forex market. The bid price is the amount for which you can sell your currency and the ask price is the amount for which you can buy the currency. The ask price is always more than the bid price. The difference between the two is the spread. If there is a great difference between the ask price and bid price (a wide spread), then the currency is more expensive. This is because the spread is the amount that dealers take as a fee, rather than a commission on the sale. The more liquid the currency pair is, the narrower the spread will be. The spreads may change throughout the day, too. For instance, when the London and New York forex markets are open at the same time, there will be a very small spread between the GBP/USD pair, since there is a lot of trading going on between the two.

The change is the amount that the currency is up or down on the day. Currency trading takes place 24 hours per day through trading centres located all over the world. The day starts at 9pm GMT, when it is early morning in Australia. Australia is the first market to open each day, followed by Tokyo, London and then New York. The hours that markets are open overlap at some points, creating a seamless 24 hour trading period. The trading week is from Monday when the Australian market opens until Friday at 5pm EST, when the New York market closes for the weekend.

More on Forex Quotes

Forex Quotes

Now let’s look at the example chart and dissect each quote to understand what they mean. In the first row, we have a EUR/USD currency pair. The euro is the base currency and the US dollar is the counter currency. This means that 1 euro equals 1.4031 US dollars. As a buyer, we are going to pay the ask price of 1.4031 USD for 1 EUR. If we are instead the seller, then we will receive 1 EUR for every 1.4029 USD (the bid price) that we trade. The US dollar is down .0045, or 45 pips on the day in this case.

A pip is a unit of measure in foreign exchange. It is the smallest measured value in a currency quote and is always the last numbers after the decimal. All quotes except those involving the Japanese yen are measured to 4 decimal places. So if the ask price of the EUR/USD pair goes from 1.4031 to 1.4032, that is an increase of 1 pip. If it goes from 1.4031 to 1.4019, that is a decrease of 12 pips. If the last number is a zero, it may be shown as only three numbers. For example if it were 1.4030 it might be displayed as 1.403. For quotes involving the yen, the second number past the decimal represents 1 pip.

Looking at the second row in our example we have the GBP/JPY currency pair. This quote shows that 1 pound equals 126.38 yen when buying or if selling, we will receive one pound per 126.31 yen sold. The yen is up 9 pips on the trading day.

Forex Risk

Currency quotes change very quickly throughout the day. The volatility is one aspect of the risk involved in trading currencies. Prices can change in an instant and in the forex market it is relatively easy to hold large positions in each trade. This is because the margin requirements for forex are much less stringent than in other markets, such as the stock market.

Buying Forex on Margin

Buying on margin is when the investor borrows money to make investments with a certain amount of their own cash plus the investment itself as collateral. This is also called leveraged purchasing, or using leverage. In equities, margin rates are around 50%, meaning that if you had £100,000, you could possibly purchase another £50,000 worth of equities on margin. In forex, investors could potentially use leverage to control 100 times their investment in currency value. That means that for only £1000, a forex investor could potential purchase £100,000 worth of currency. This can be a slippery slope for inexperienced investors, who can suddenly find themselves way over their heads and deep in debt.

Because currencies are traded in such large numbers, it does not take long for the markets to move quickly. Percentage changes may be smaller but with so much capital on the line, even a small movement can be devastating, especially for leveraged trades. For instance, if one were to maximize their leverage on £10,000 and purchase £1,000,000 worth of another currency, just a 1% change in value would result in a £10,000 loss – equal to their entire investment amount.

On the other hand, with the same investment, a 1% gain would result in 100% return on the original investment. This is the incredible lure of trading forex. Minimal investments utilizing leverage can lead to very large gains in a short amount of time. Just be sure if you get involved in forex that you have a very strong understanding of the basics and then start trading small. It is much better to begin with a practice forex account, which is available at a number of forex sites for free, than to jump into a trading account. Learning forex with a real money account can be a very expensive education indeed, while making mistakes on a practice account can provide invaluable lessons.