Many people just getting started with investing have never even heard of Forex. They start searching for ways to make money using the stock market and find themselves on a Forex sales page. Without really knowing what they are getting into they dive in. This is a recipe for disaster. Forex is a great way to make money in financial markets, but it is just as good of a way to lose money.
What is Forex?
Forex is trading currency. If that doesn’t make sense that is fine, most people don’t understand it off of its definition. What Forex traders do is they use exchange rates between countries to rapidly exchange currencies, pocketing the difference as currency values rise and fall. Forex is actually the most actively traded market in the world and trades more than $5 trillion every single day.
Many forex traders start out with a forex demo account to figure out strategies and get an idea of how everything works. They then go from there to using real money.
Why investors like it
Investors love Forex for a few reasons. The first one is that forex is what is called a leveraged product. This means that even if you only have $5,000 to trade, you can actually purchase more than $5,000 in currency. Essentially you are able to borrow money from your broker and then pay them back with your assumed increases and earnings. For example, let’s say you have $5,000 and you make some good trades and increase your money by 20%. You would have made $1,000. If you instead leverage your money, you are actually investing $10,000, even if only $5,000 is yours. You are expected to pay the money back to your broker eventually. If you make 20% with your $10,000, you are now up $2,000 instead of $1,000. Essentially you made a 40% increase when you only should have had a 20% increase. It all sounds great until the same thing happens on a decrease.
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Another reason people love forex is timing. Forex markets are open 24/5. They open Sunday and don’t close again until Friday. Not only can traders invest all day and night if they choose, but this eliminates some of the gaps that often show up in the stock market. Often when a company announces bad or good news after hours in the stock market there will be huge stock movements the next day as everyone jumps in or out at once, this is slightly more limited in forex.
What affects prices
To trade successfully in forex you essentially have to be able to predict the future value of certain currencies. This may sound impossible, but many Forex traders do it successfully every single day. There are obviously quite a few factors that go into the price of an exchange such as politics, economics, or natural events.
As with most financial trades, Forex traders try to identify patterns in pricing and use those to make a quick profit. Some of the most common ones are using what is called moving averages. Essentially you look at the average exchange rate of a currency over a certain period of time. You will start to see trends. If a short-term moving average climbs above the long-term moving average than you have a good indicator.
Other traders prefer to use another simple method called momentum trading. This is exactly what it sounds like. A trader is trying to catch the momentum of some event that just occurred. For example, when Brexit occurred last year there were literal explosions of volatility in exchange rates for days. Momentum traders were able to capitalize on this and jump in and out quickly, pocketing large differences in the process.
There are a lot of strategies that work in Forex. The real key is to know what you are doing, come up with a strategy that works, and stick with it. People usually lose money when they break from their strategy.