If you have ever heard about people making millions (or losing millions) of dollars on currency speculation, you are not alone. I have read stories about being making and breaking the bank by investing in Euros, Pounds, Yen, Shekels, Yuan, Baht, Pesos, and a slew of other currencies. From the grand entrance of the Euro to the Asian Currency Crisis in the 1990s, the Foreign Exchange, or FOREX, markets are an important investment opportunity.
Before you put any money into a FOREX account, I want to put out a big disclaimer. This is a high risk investment where you can lose a lot of money very quickly. Only invest in FOREX if you have a lot to lose without worrying and you are very well versed in all of the mechanics of this type of investment.
Betting on Economies
People are always looking for interesting places to invest. If you have a high net worth and are looking to diversify into more risky investments, FOREX is an exciting place to put your money. Rather than investing in the future of a company, however, you are betting on the relative position of two currencies, generally tied to the health of the two national economies.
For example, if the United States has a growing economy while the economy of Great Britain is suffering, the United States dollar (USD) may rise relative to the Great British Pound (GBP). However there is a lot more to it than that.
The two economies are interrelated with trade and other investments. The balance of trade between the two countries may have an impact on exchange rates. At the same time, each country has its own government and national bank regulating interest rates, currency supply, and a handful of other monetary and fiscal policies.
A Global Economy
You have to take this analysis one step further, however. The economy of the United Kingdom, which has its own currency, is highly impacted by the economy of the 17 Eurozone countries. Today, some of those countries are struggling with debt issues, weighing down on the Euro (EUR). While the UK does not use the Euro, it is impacted by the Eurozone debt crisis.
The United States is also impacted by the Eurozone, as are most economies in the world, but no currency is going to be impacted more outside of that zone than the British Pound.
If this is exciting for you, companies like Zecco Forex have accounts that allow you to trade on foreign exchange markets.
Some governments, such as the United States and Switzerland, have very strong monetary policies. When times are tough, it is easy for a government to print more currency to pay the bills. However, more currency means the value of the currency is going to drop quickly. Printing money leads to serious inflation.
The worst recent example of hyperinflation is Zimbabwe. If you bet that the Zimbabwe dollar (ZWL) was going to go down over the last decade, you would have made a lot of money. In fact, at the peak, Zimbabwe had inflation of 98% per day in November, 2008!
As a collector, I got ten $Z100 trillion dollar bills. That makes me a quadrillionaire. I could buy a loaf of bread with that.
Foreign exchange rates are represented using a ratio. In most cases, currencies are shown as conversions to the US dollar or the Euro. You may be able to convert directly between two foreign currencies, but often times you have to convert with either the dollar or Euro as an intermediary.
A recent EUR/USD quote is 1.2504. That means each Euro is worth $1.25 in dollars, or one dollar is worth €0.799 Euros.
Currency exchanges charge fees to convert, so your actual rate will be lower than the quoted rate. The fees generally depend on the volume and size of your trades.
Invest in Foreign Stocks
If this is a little scary for you, you can also look into other ways to get exposure to currency investment without buying a currency. One way to do that is to buy foreign stocks.
Investing in a safe, “blue chip” like company in Europe would give you exposure to the Euro, as your return would include fluctuations in that currency. Large utilities, food companies, and international brands are a good place to start. Look at the Dow Jones Euro STOXX 50 for a list of the biggest European companies.
You might not be able to buy those companies on the New York Stock Exchange or NASDAQ, but you can easily buy them as an ADR through any broker. Just make sure you brokerage does not charge any big ADR fees before trading.
Proceed with Caution
As I mentioned above, currency trading can be very risky. You might be able to make a lot very quickly, but you can lose a lot as well. Unlike investing in equities, you can’t do a solid fundamental analysis of a company for the long run. You are dealing with trade balances, politicians, natural disasters, sovereign debt, and a load of other variables.
If you are looking for a no-risk way to try it out, Zecco offers a $50,000 practice account to get you started for free. If you like it and feel comfortable, you can add money to your account and trade for real. If not, it is free to try the practice account with no obligation.
Have you ever invested in foreign currencies? What was your experience like? What are your thoughts on trying it out? Please share in the comments.
4 thoughts on “How FOREX Works”
Too complicated for me! Seems like it would be easier and just as likely to make you money if you went down to the local casino to place your bet!
It is very complicated! I think it is a bit safer than the casino if you know what you are doing, but if you are not well versed you have better odds at Black Jack.
I’ve made some trades in forex but for now I feel more comfortable working with the stock market.
How did your trades work out? Any lessons you can share?
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