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The foreign exchange (forex, or FX) market is by far the world's biggest. Daily turnover is about ten times that of global equity markets – and very liquid, so deals of all sizes and in virtually all currencies can be done quickly and easily.
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We have received a number of requests for information about foreign exchange trading or Forex for short. We published an 'In Brief' article some months ago, based on an original piece in Money Week (an excellent magazine that we heartily recommend). It was very popular at the time and we have therefore decided to update it and provide some additional information.
Forex trading is perhaps not for widows or orphans. But the basics can be
mastered quickly, especially since spread betting has opened the market
up to retail investors, making it more accessible than ever. And even if
you don't fancy trading, it's worth at least understanding what drives
the markets.
As we all know from recent events, stock markets around the world can all fall at the same time, but because currencies are valued relative to one another, if one weakens then another must get stronger. That means there is always money to be made.
First off, you place currency bets in pairs. Spread betting firms, such as IG Index and Capital Spreads, will allow you to do so. Choose a currency pair, say sterling (GBP) against the US dollar (USD), invariably shown as GBP/USD. You buy it if you think the pound will rise (strengthen), and sell it if you think the pound will drop (weaken). The key point to note is that when you ask to buy or sell, your instruction refers to the currency on the left of the quote. So and order to 'buy GBP/USD' is a bet that the pound will do well against the US dollar.
You then decide how much to bet per point (a point represents the last digit in a standard quote, often referred to as a 'pip'). So, for example, you could buy the GBP/USD pair for £5 a point, having been quoted a spread of 1.6850/1.6853. If sterling strengthens you might close your position by selling the same pair, now quoted at 1.6865/1.6868. Your profit is 12 points (16865–16853 = 12), which is £60 at £5 a point, tax-free. If, of course, sterling had weakened, you would have lost money.
Unlike stock exchanges, forex is a 24-hour market, so you can trade at any time, unlike with stocks which can only be traded during market hours. Also, as noted above, currencies are a relative game, so “there’s always a bull market somewhere”, as traders like to put it.
Trading individual currencies also requires a decent knowledge of the factors that could influence exchange rates, so currencies can also give you a way to play changes in sentiment driven by big macro economic moves. For example, one of the big drivers is expectations about relative interest rates – a rising Bank of England base rate, relative to the equivalent US Fed rate, would usually make sterling attractive relative to the dollar and push the GBP/USD rate up. So if you have a view on interest rates which differs from market expectations, you can profit from that by betting on the currency markets. There are of course a host of other factors that will move currencies, such as data on government debt, economic growth and inflation among others. This is sometimes referred to as 'fundemental analysis'.
On the other hand, 'technical analysis' is the study of chart patterns and the theory is that patternes repeat themselves over time and therefore by studying charts you can work out what is likely to happen in the future. Most traders will use technical analysis, but will keep one eye on the fundementals.
Unfortunately there is no substitute for experience, but there are some short cuts and you can get to know the basics fairly quickly. Whilst most professional traders have a system that they have developed over years, it is possible to develop your own simple strategy using just a few indicators and, with patience and diligence, it is possible to make money. Perhaps an easier route is to use a published strategy that has a proven track record and these are available from a number of resources. You can also buy trading strategies and systems from various resources on the internet - some are better than others and a little research will usually pay dividends. There are a couple of useful blog sites that publish articles by a number of different individuals (and so the quality of the writing varies a bit), but you should be able to find a few nuggets that will be worth looking at in more detail.
Take a look at http://forexforseniors.com and http://startinginforex.com to get some ideas.
One thing to be very wary of (in our opinion) are automatic trading systems, frequently called 'robots' that purport to trade for you automatically. This is the holy grail of Forex and banks spend millions developing highly complex computer algorithms to automate the process. As far as we know, they haven't succeeded yet.