The biggest money market on earth
One of the biggest ways to make money using the internet is from trading currency online by taking advantage of the benefits of Forex trading. Trading money has been around for a very long time already and it is a legitimate business that you can do yourself from home. However, starting out with Forex trading can be quite a difficult task. It is necessary that you know the basics, understand the language, and become confident with your knowledge before venturing online with your own Forex trading business.
Currencies are important to most businesses around the world because currencies need to be exchanged in order to conduct foreign trade. If you are living in the U.K. and want to buy milk from Belgium, either you or the company that you buy the milk from has to pay the Belgians for the milk in Euros. This means that the U.K. importer would have to exchange the equivalent value of British Pounds into Euros. You can see from this example that with globalisation increasing year on year, the size of the Forex market will likely keep increasing as well.
Most individuals begin Forex trading by signing up to a specialist online Forex trading site, with two of the biggest being CMC Forex Market Trading, and IG Forex Trading. Take a look at these websites and get a feel for their layout, and if you feel ready, sign up for a trading account. There are many other Forex trading websites that are available, and most have a wealth of information about the process of making trades and how the system actually works. However, we will cover a brief introduction to Forex in the rest of this post.
What does Forex trading involve?
The simplest explanation of Forex trading is the buying or selling of currencies in order to buy one when it’s low when priced against another, and then sell when the value changes. For example, if you believe the British Pound will gain in value against the US Dollar, you can place a trade and bide your time until the Pound does indeed rise in value, resulting in a profit for you. The goal here is that you exchange the currency from one form to another hoping that the price will change and the currency you bought will increase in value, therefore making a profit. As an example, let us use Euros and US Dollars.
You bought 10 Euros, and at that time the rate is at 1.1800. A couple of weeks after that, you exchange it to dollars and the value is at 1.2500. You therefore make a profit of 0.07 (1.2500 – 1.1800), multiplied by the amount of currency purchased, minus any transaction fees.
These currencies are traded on the FOReign EXchange (FOREX) market in vast volumes each day, and it is a known fact in the world of finance that the Forex market is by far the largest and most liquid market in the world, dwarfing the stock and commodity trading markets. In fact, current estimates for the volume of daily Forex trades reside in the region of 5 Trillion US Dollars per day!
One difference between stock trading and Forex trading is the fact that Forex is traded across all international time zones, with at least one of the major financial centres being active at any time. So when trading finishes in the UK, it could still be active throughout Asia, with price quotes changing constantly. Therefore, unlike stock trading you could potentially trade Forex around the world 24 hours a day.
It is very easy to place the trade in the foreign exchange market, and it is actually quite similar to how you would do it in the stock market. If you have prior knowledge with stock trading this should be an easy concept to understand, but to illustrate it, let us look at a few of the specific ideas that are involved with Forex trading.
There are actually three ways individuals can trade Forex, with these being the spot market, the forwards market and the futures market. However, as an individual trader you will almost certainly want to concentrate on the spot market as it is by far the largest of the three, with forwards and futures markets generally only being used by institutional traders.
What are the Forex markets?
Just to clarify what the Forex spot market actually is, it can be defined as the market where currencies are bought and sold according to the current price. This market is manipulated by the laws of supply and demand, just like the stock market is, and there are many factors which will cause the constant changes in currency valuations. These include; current interest rates, local and international ongoing political situations, and the current performance of one currency against another. All these events are outside of the control of the individual trader, and yet all can be instrumental in how much of a profit or a loss you can make. Bearing this in mind, you must decide for yourself if you feel you have enough of an awareness of current affairs to make an informed decision whether or not you should be making Forex trades.
However, if you do go ahead and trade one currency against another, you will have completed a transaction known as a ‘spot deal’ in trading terms. This spot deal is the agreement between the buyer and seller of the separate currencies to exchange funds at the current exchange rate (known as the ‘spot exchange rate’). Once the agreement has been made and finalised, the exchange of money takes place and the deal is then legally binding.
Most of the time, the amounts sold and bought are to the thousands, so if you are someone with the available funds and you feel confident enough to invest it you should give Forex a try. As previously mentioned, if you have prior experience trading shares then you should feel comfortable with trading currencies.
What are Forex quotes?
Whenever you research which currency pairs to buy, you will come across the Forex quote which will tell you how much you need to pay for a unit of the base currency. When you sell, the rate of exchange will tell you how many units of the quote you will get when you sell the base. When trading Forex, you have to understand the Forex quote. When you look at a quote, you will see that it is in pairs, which details the trade from one currency to another, and usually relates a local currency to a foreign currency. For example, if you have a quote for GBP/USD, then GBP is the base currency while the USD is quote currency, and the quote simply reflects the value of one against the other.
As an example, let us say we are looking at the Forex pair between the British Pound (GBP) and the US Dollar (USD), the Forex quote would look like this:
GBP/USD = 1.3
The base currency (GBP) is always equal to one unit, and the quoted currency (USD) is what that one base unit is equivalent to in the other currency. Therefore, the quote we are looking at means that GBP £1 = $1.3 USD, or to put it another way, 1.3 US Dollars will buy 1 British Pound.
The effect of spreads
You will also need to consider the buy and sell spreads when you trade currencies as they can have an effect on what your returns will be. The ‘spread’ is simply the difference between two prices, because the buy price (also known as the bid price), and the sell price (also known as the ask price), will not always be the same. To make matters even more confusing, the buy and sell prices are from the market perspective, not yours, so the bid price is actually the price the market will buy the currency from you. Likewise, the ask price is the price the market will sell the currency to you.
Therefore, if you buy one currency at a certain price and then immediately try to sell it, you will likely lose money, because the price at which the market will buy it back will usually be lower than what you have just bought it for. If you have any experience of trading stocks online then you will already have seen this effect in action.
You will find that the Forex quote can be displayed with an additional number that takes into account the bid/ask spread, normally in the following format;
GBP/USD = 1.3000/50
The number before the slash is the bid price, or the price you can sell British Pounds in US Dollars, whilst the two digits after the slash indicate the ask price (or the price you can currently buy British Pounds in US Dollars). The bid price will always be smaller than the ask price, so in effect it is impossible to make an immediate gain in Forex trading, and hence you will have to wait to see which way the bid and ask prices will move.
To clarify how this spread is shown in the above quote, we can see that it only represents the last two digits of the quote, so;
GBP/USD = 1.3000/50
Bid = 1.3000 (The price at which you will be able to sell GBP in USD terms)
Ask= 1.3050 (The price you will be able to buy GBP in USD terms)
What this means is that there is a difference of half a cent between what you pay to buy the same currency pair, and what you would receive if you were selling it. The spread is usually made even bigger by the brokerage firm so that they can take some profits from every trade that you make, which will further decrease your returns.
Keep your risk low
Most Forex traders will tell you that the most important thing to remember when trading is to keep your risk to an absolute minimum, with around 1% potential loss per trade being the norm. So if you have a £3000 trading account you would not want to lose more than £30 per individual trade. During the course of a day, you could make 100 trades and lose 1% on 45 of them, but if you have made 1% on the other 55 trades you will be up 5% overall. We can also add what is called a ‘stop loss’ to each trade, so that the maximum potential loss will be limited to a set value, with the trade being made automatically to prevent further losses if the currency value starts declining too much.
You can probably see by now that Forex trading can be extremely complicated, in much the same way that trading stocks is. However, for those who are willing to do the research and learn all the ins and outs of the process, Forex trading can be a potentially extremely lucrative way to make money online. Ultimately, it is highly recommended that you research Forex trading much deeper than this introductory post, and preferably sign up to a broker that allows you to make ‘trial trades’ that do not include the use of real money, before risking your own hard-earned cash.
All content provided in this post is correct to the extent of the authors knowledge. If you have any comments, please add them in the comments section below.