Investing in Forex: The Basics

Investing in the foreign exchange (forex) market is a potentially profitable venture for those with a good understanding of the marketplace. Trading currencies in the forex market can potentially yield high rates of return, as well as providing a unique investment opportunity with substantial leverage. In this article, we’ll look at the basics of forex investing and provide some insight into why it can be such an attractive option for many investors.

What is Forex Investing?

Forex investing is the act of trading foreign currencies in the foreign exchange market. The forex market is the largest financial market in the world and trades over $5.1 trillion daily (as of April 2020).¹ It is made up of currency pairs where the value of a currency is compared to the value of another currency. Traders buy and sell the currency pairs, aiming to profit from changes in their exchange rates.

The forex market is a 24-hour market and is constantly in flux, reacting to news, economic data, and geopolitical events. As a result, the pricing is constantly changing and presents a unique opportunity to make a return on an investment. Forex investing requires a certain degree of expertise and experience, so it is important to have a good understanding of the forex market before investing.

What Makes Forex Investing Attractive?

The primary benefit of forex investing is its potential for high returns. As a result of the leverage that is commonly available to traders, forex investors may be able to generate substantial returns in a short period of time. Leverage is the ratio of capital to the capital held by a trader and allows traders to increase their potential returns by taking on more risk. Leverage ratios of up to 200:1 are available to forex investors,² and this could potentially increase profits if used wisely.

Another reason why forex investing is attractive to some investors is the lack of commissions charged when trading. Because brokers do not charge a commission when trades are made, investors’ profits are limited only by their own trading skills. This means that investing in forex can be lucrative if a trader has done the necessary research and honed their trading skills. Lastly, the 24-hour nature of the forex market means that it can be accessed at any time, making it especially attractive for those who do not have regular access to traditional markets.

The Risks of Forex Investing

One of the key risks of forex investing is the use of leverage. As mentioned, leverage can increase profits but also carries a high degree of risk. The more leverage that is taken, the greater the potential reward but also the greater the potential risk of large losses. This risk is coupled with the fact that forex markets are highly unpredictable and thus, investing without proper risk management could be very costly.

In addition to leverage risk, forex investors also face the risk of liquidity. Forex trading is conducted on a global scale and the markets can be very volatile. As a result, there may be times when it is difficult to exit a position in a timely manner and the investor may face a large loss that is difficult to recover. Lastly, currency values are affected by global events, and this can make predicting currency movements highly difficult and give rise to substantial losses.

Final Word

Forex investing can be a potential source of high returns, but it carries a high degree of risk. Before investing, it's important to have a thorough understanding of the forex market and the risks associated with it. This can help to ensure that forex investing is done in a safe and responsible way that minimizes risk and maximizes potential rewards.

Source:

1. “Triennial Central Bank Survey”. Bank for International Settlements, 2020. https://www.bis.org/publ/rpfxf19fx.pdf
2. “Forex Trading: Understanding Leverage”. Investopedia, 2020. https://www.investopedia.com/articles/forex/11/understanding-forex-leverage.asp
3. “Foreign Exchange Market”. Investopedia, 2020. https://www.investopedia.com/terms/f/foreignexchange.asp
4. “An Overview of the Foreign Exchange Markets”. Harvard University Extension School, 2020. https://isites.harvard.edu/fs/docs/icb.topic1028417.files/Overview%20of%20the%20Foreign%20Exchange%20Markets.pdf
5. “Risks in Forex Trading”. Blackwell Global, 2020. https://www.blackwellglobal.com/trading-academy/risks-in-forex-trading/