Trading The Forex Market

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The first question to address is whether forex investing is for you. Forex is one of the most liquid, ie. volatile, markets in the world. Stock and bond trading typically requires you to put up an amount equal to the price of the paper you’re trading. This 1:1 leveraging greatly decreases your risk, regardless of volatility. Forex, however can allow up to 250:1 leveraging. Leveraging increases the risk that you could lose your entire investment, and more, despite the opportunity of high profits. It’s imperative that you truly understand your risk tolerance levels so that your trading experience relies on calculated analysis rather than emotional roller coasters. The questions to ask are whether you’re able to stomach the losses that traders inevitably experience, and are you disciplined enough to stick to strict rules governed by evidence rather than emotion.

The next question to address is how forex is traded. There are 3 types of forex markets to trade: spot, futures and options. The spot market deals with the currency itself, making you a buyer an seller of pounds, marks, francs and dollars, while the currency futures deals with futures contracts on those currencies. Both of these markets deal separately with high leveraged risk, but can be combined and traded together to create positions that are protected against adverse market moves. Options give you the opportunity to limit your risk while creating unlimited upside potential, and provide a useful tool to create more hedged speculative positions. Trading forex should involve a combination these three markets so that your positions can withstand the high volatility inherent in currencies.

Currencies are traded in standardized lots, and require you to put margin up to operate these lots. This margin can be geared to your risk comfort levels so as to limit your exposure to market moves. As each currency is traded, price moves are measured in pips, with each pip representing the minimum price change in a particular currency. Your profit or loss is calculated by a multiplier that’s determined by the lot size and pip, and is credited to or debited from your account immediately upon liquidating your positions.

Spot forex and its options are a relatively unregulated market, that is, an over-the-counter (OTC) market, with no central exchange, and electronically trade currencies from all over the world 24/7. Currency futures and their options are governed by the CFTC here in the US, however, and can only be traded through a registered brokerage. You can sign up with any brokerage specializing in forex simply by filling in an application, signing the appropriate risk disclosures and demonstrating the necessary capital requirements. Be sure to understand the spread (commission) the brokerage will charge per trade, as that can severely hinder your ability to profit, and in fact contribute to your losses.

There is an extensive library on forex investing available, as well as a wide variety of systems and strategies to fit the day-, swing- and position-trader. If you have more specific questions about currency trading, and would like a free book, “Forex for Small Speculators” by Noble DraKoln, feel free to email me.