Currency trading (aka forex) has become highly lucrative and increasingly popular in this age of global volatility and sovereign debt messing with exchange rates. But many of us are intimidated by the concept, seeing as our only experience with currency fluctuations is limited to foreign vacations and how they impact our credit card bills.
To get started with forex, you first have to understand the complex nature of global currencies and how they are very much a measure of confidence in the underlying governments and economies they support, not just directionally relative to their past but also versus peers elsewhere in the world.
For instance, the strength of the U.S. dollar might not seem like a sure thing to you as our federal deficit soars and unemployment remains high at home … but considering the alternatives in the world are the debt-addled eurozone or struggling emerging markets, things are looking pretty darn good for the greenback. Currency trading has as much to do with geopolitics and investor sentiment as it does with macroeconomic data points.
Even if you can accurately gauge what way currencies will move based on your analysis, the bottom line is that forex is a game of tiny increments — fractions of a cent, taken in large quantities to create profits. That means a constant connection to the market to take advantage of these small moves (akin to day trading) and the use of leverage and margin to maximize your investment profits. It also means paying close attention to your spreads to ensure you pay the lowest amount possible for your transactions. Every penny and fraction of a penny counts!
That brings up the biggest risk of all: Because forex involves such tiny moves and the need for big bets to make any money, it’s easy to get over your head. If an investment seems great but you have to plow a huge amount of cash into it to make the math work … well, that’s good if things go as planned. If not, you can be left with a very costly mistake.
Forex brokers vary in their services and scope, so shop around. Unlike equities, forex transactions don’t involve a commission, but rather a small fee based on the difference in spreads between what you can buy or sell a currency at. The bottom line is that lower spreads means lower cost, so browse like you would for commissions on a brokerage account. Also pay attention to margin rules and flexibility in leverage. As with short-selling, a dreaded margin call is possible if you don’t read the fine print or prepare accordingly.