Investing 101: FOREX

(It’s Tuesday again, and you know what that means!  Yes, yes, only three more weekdays until it’s time to party, but in addition to that, it’s time for another edition of Investing 101!  We’re getting a bit more exotic in our chosen investments, in this case, covering forex, which is really more speculation than investment…)

Q: What is forex?

A: Forex is short for foreign exchange, that is, the relative values of different currencies around the world.  When speculating in forex, you buy or sell pairs of currencies, attempting to determine how the exchange rate between the two will change.  For example, the US Dollar and the Euro are bought and sold in the currency pair EUR/USD.

If you think that the US dollar will fall compared to the Euro (so the EUR/USD ratio will rise), you can buy this pair and benefit from the dollar’s fall.  If you feel that the dollar will rise (decreasing the EUR/USD ratio) you can sell this pair instead, and make a profit when the ratio decreases.  There are ratios corresponding to numerous currency pairings, including all the major and many of the minor currencies around the planet.

Q: How did forex come into existence?

A: Forex was originally created for use by hedge funds and large corporations that do business in multiple currencies, allowing them to hedge against the possibility that the currency fluctuations will decrease the value of their foreign holdings.  If you are an American company and are afraid that rising exchange rates with the Euro will decrease your profits from your French sites, you can sell the EUR/USD currency pair to decrease the risk of losing money from such a fall.

Q: How can I fit forex into my portfolio?

A: Well, as mentioned before, forex trading is speculation, rather than an investment.  Don’t put your money into forex expecting to hold the currency pairs for a long period of time; if you aren’t planning to day trade, you probably should just avoid forex.  Plus, because the lot sizes for forex trading are so large (typically about $100,000), you usually need to take on a great deal of leverage, usually in range of 100 times as much as your own investment.  This means you will be potentially amplifying your gains, but also have the potential to lose more (much more) than you initially deposited.

Q: What else should I know about forex?

A: There are a few things you should consider doing in order to get yourself ready for forex trading.  (That is, assuming you still want to go into forex; as mentioned previously, there’s no pressing need.)  In order to get ready:

Take some time to practice forex trading: Most forex trading companies will allow you to set up a practice account to test their platform.  Doing so, and taking many weeks, if not months, to practice will make you much more capable of doing well when you decide to speculate for real.

Know how much you could conceivably lose: Given the high leverage levels, you can stand to lose a great deal of money.  While you are practicing, make sure to note how much money you lose when your trades go wrong.  Make sure you have enough money ready in your account to cover any loses above and beyond your initial investments.

Keep the money you put into forex to a minimum: Be sure that when you put money into forex that it makes up only a small portion of the money you invest.  Because of the potential losses you can suffer, you need to be sure that you have only a small amount of your investment money put into forex trading.  I’d say no more than 10% of your portfolio should be used for speculating in forex (and probably much, much less, until you know exactly what you are doing).

That’s the short and quick version about forex trading; hopefully, this will help you to decide if this form of speculation is right for you.

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