The foreign exchange markets or forex markets for short are the largest markets in the world, essentially where money of currencies are exchanged. Say for example if I was to travel to India for a holiday and I have $1,000 to spend. I need to change my $1,000 Australian Dollars (AUD) into Indian Rupees (INR) which at today’s rate gets me about ₹48,000, since $1 AUD is worth about ₹48 INR. So, I go down to my bank and give my $1,000 AUD which the bank trades on the international foreign currency markets or (forex markets) to get me the ₹48,000 INR.
The forex markets are traded not only by banks but also by corporations buying and selling goods and big funds run by investment managers or hedge funds which make a profit by buying and selling the currencies. It is also possible for individuals to trade currencies on the forex markets using an online trading account such as Saxo.
How does it work trading currencies?
Using a forex online trading account individuals can use a number of financial products to trade currency. In the above example I changed my $1,000 AUD into ₹48,000 to go on a holiday, let’s say I missed the flight and tried to change my money back, however, the AUD has depreciated against the INR and is now $1 is worth ₹45 INR. When I change back my ₹48,000 at that rate I now get $1,066.67 back for my money, excluding that I didn’t pay any fees to change my money and the fact I missed my flight I have just made a profit of $66.67. That’s essentially how forex trading works, making a profit buying and selling with the fluctuations in the forex currency exchange rates.
It’s actually a little more complicated than that as trading using an online account you use leveraged complex financial products called derivatives which multiply your profits (and losses!). An example of how that works is let’s say I took that $1,000 AUD and used it to purchase a right but not the obligation to sell the $100,000 AUD worth of Indian rupees INR. When the value of the AUD drops from ₹48 to ₹45 I make a profit of ₹3 per $1 which is ₹300,000 or around $6,666.67 since I hold the option to sell for a higher price. Not bad right?
Are there any risks in forex trading?
Short answer, it’s probably one of the riskiest financial products available to individuals like you and me.
Using the above example again let’s say the AUD appreciates in value to the INR by ₹3. Since I purchased the right but not the obligation to buy at ₹48 and the current price would be ₹51 so effectively my right is worthless. In that example I had the right but not the obligation so I only lost $1,000, there are other products which are even riskier such as “contracts for difference” where you have unlimited potential for losses.
At the end of the day, there are hedge funds with teams of expert staff with decades of knowledge trading in forex which end up going bankrupt. So, what makes you think you could be better than them?
Should I trade in forex?
Personally, I don’t trade in forex, not because there is no money to be made but because it’s not something I really understand. Currency markets are incredibly complex, so many variables can affect the supply and demand of a particular currency so it’s incredibly hard to predict. Admittedly I have never really spent the time trying to learn forex trading so don’t take my word as gospel as I am no expert on the topic.I have met people who do make a tidy profit trading forex, but usually they have years of experience and have worked in the industry.
If you really are interested in getting started in forex trading I recommend you learn as much as you possibly can, don’t be a cowboy and start firing off speculative trades as its probably the same risk as gambling at the casino, only less entertaining and ‘possibly much larger sums.
There are many great books out there, read as many as you can, attend seminars then gain experience trading in a fake environment and learn from your mistakes. Maybe then if you feel confident enough you can give it a try by starting with small sums. Realistically speculative investments such as forex trading should only be a small part of a larger investment portfolio, say 5% for example. If you’re an impoverished student such as most of the readers of this blog then you probably have better uses for your money, such as paying tuition fees, food or saving for a rainy day. Ultimately its up-to you to make your own decision, choose wisely.