Forex trading involves trading foreign currencies against each other as some strengthen and others weaken. It's an advanced strategy that requires upfront research and some understanding of how currencies work.

Tutorial: Forex Trading



The Basics of Forex Trading

When engaging in forex trading, you are simultaneously purchasing one currency and selling another. For example, if you purchased Japanese yen and sold U.S. dollars, you would be going long JPY/USD. Over time, the foreign exchange rate of the yen compared to the dollar will change. When you close out the trade, you will have either a gain or a loss when you sell yen and purchase dollars.

When you open the trade, 100,000 yen may cost you $1,300. If the dollar weakens, your trade is worth more over time. When you close the trade, you will sell the 100,000 yen for more that you bought it for. It may be worth $1,400 and you will have made a gain of $100 on the trade. Most currencies can be traded on established forex markets, but the U.S. dollar, the euro and the yen are the most commonly traded. (Currencies can provide diversification for a portfolio that's in a rut. To find out which ones you need to know, see Top 8 Most Tradable Currencies.


Brokerages
Forex trades are conducted through brokerages. Many brokerages have an online trading platform. When you place an order on your account through the broker, the trading house sends the order to the Interbank Market to fill. The Interbank isn't a bricks and mortar establishment, but a network of traders and banks that deal in currencies.

As with stock brokerage houses, some forex brokers offer guidance and advice with trading and others leave you to trade on your own. The costs and fees to maintain an account and to conduct each trade vary from broker to broker. Popular brokers include CFOS/FX, ForeFront Forex and Infinity Brokerage Services. (If you're a rookie investor, your first big investment decision should be an informed one. For advice, check out Picking Your First Broker.)

Trading on Volatility

This year is a particularly volatile time for forex trading, which can mean larger gains and larger losses. The United States and many European countries are facing unprecedented budget crises, political instability and natural disasters. All of these factors will have an impact on the value of currencies and their relationship to each other. The continued strengthening of the yen against most other major currencies makes it a good bet in the short to medium term and JPY/USD trades are popular.

Dangers to Avoid
While making gains on forex trades is the reason investors get into the game, losses are always possible. Currencies are particularly susceptible to swings due to major events - most of which are unpredictable. An unexpectedly negative jobs report, a major earthquake or the death of a foreign leader can all lead to large and immediate downward currency movements. Losses can mount in minutes if you are on the wrong side of the trade.

The best way to avoid this type of devastation in your forex portfolio is to put a stop loss on every trade. A stop loss is a point at which your broker will automatically unwind your trade. It limits your losses when there are sudden swings and protects your capital investment. If you are gaining on trades, you can always set the stop loss point higher to lock in some of the gains. (For more read The Stop-Loss Order - Make Sure You Use It.)

The Bottom Line

Forex trading can be exciting, whether you day trade it or stay in for the long haul. Dealing with a reputable brokerage can mean the difference between making money and losing it. With the expected continued world volatility in the near future, there is a lot of money to be made in the forex market. (For a complete guide on forex trading tips, check out Forex Trading Rules.)

Related Articles
  1. Forex Strategies

    These Are The Best Hours To Trade the Euro

    Six popular currency pairs and numerous secondary crosses offer euro traders a wide variety of short- and long-term opportunities.
  2. Mutual Funds & ETFs

    7 Best ETF Trading Strategies for Beginners

    Exchange-traded funds are ideal instruments for beginning traders and investors. Learn the seven best strategies for trading ETFs.
  3. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Biotech Sector

    Learn about the top biotechnology ETFs, such as the SPDR S&P Biotech ETF, the First Trust NYSE Arca Biotech ETF and the iShares Nasdaq Biotech ETF.
  4. Stock Analysis

    4 Reasons Intercept Pharmaceuticals Should Be on Your Radar

    Learn about Intercept Pharmaceuticals and what type of biopharmaceuticals it seeks to create. Understand four reasons why the company is a good investment.
  5. Investing

    Looking To Begin Trading In The Stock Market?

    If you are a new trader, we explain the differences between penny stocks and options so you can make the best decision for your personal trade plan.
  6. Investing Basics

    Penny Stocks Vs. Forex: Which Is Right for You?

    Learn more about penny stock trading and forex market trading, and why each investment class appeals to different types of investors.
  7. Mutual Funds & ETFs

    ETF Analysis: United States Natural Gas Fund LP

    Find out more about the United States Natural Gas exchange-traded fund, the characteristics of the ETF and the suitability and recommendations of it.
  8. Mutual Funds & ETFs

    ETF Analysis: United States Oil Fund

    Find out more about the United States Oil Fund, the characteristics of USO, and the suitability and recommendations of the ETF for investors.
  9. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Oil

    Find out more about the PowerShares DB Oil exchange-traded fund, the characteristics of the ETF and the suitability and recommendations for it.
  10. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraShort Bloomberg Crude Oil

    Find out about the ProShares UltraShort Bloomberg Crude Oil ETF, the characteristics of the inverse ETF and the suitability and recommendations of it.
RELATED TERMS
  1. Transfer Risk

    The risk that a local currency cannot be converted into the currency ...
  2. Bid Wanted

    An announcement by an investor who holds a security that he or ...
  3. ICE LIBOR

    See LIBOR
  4. WM/Reuters Benchmark Rates

    Spot and forward foreign exchange rates that are used as standard ...
  5. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  6. Open Position Ratio

    The percentage of open positions held for major currency pairs ...
RELATED FAQS
  1. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  2. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  3. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  4. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!