Guest post by James Sheffley of BabyPips.com.
The foreign exchange market is the biggest financial market in the world. It’s used to make money by normal everyday people, banks, corporations, hedge funds, and central banks, and it can be as safe or as risky as you choose to make it. This control gives individual investors the freedom to protect their funds, or go for broke as they wish, without any interference, or the need to diversify your portfolio.
Theoretically the only difference between trading stocks and trading currencies is the scale of your trades, as well as the size of the enterprise that you’re investing in. Essentially, instead of buying a share in a single business’ stock, you’re buying a share in an entire country’s economy. That means that, because individual investors are so small in comparison to an entire country, it’s virtually impossible for anyone to actively manipulate the market.
Managing Your Risk/Return
In Forex trading you can use your own funds to loan and invest much larger sums of money. Since currencies represent massive economic power, their value in comparison to each other fluctuates in only tiny amounts. Because those fluctuations are relatively small compared to stocks, you can borrow large sums, often over 100 times the amount that you put in yourself. That means, theoretically, if you had 100 dollars, you could use it to get 10000 dollars worth of leverage to invest. If that then rose by 0.5% you would make 50 dollars, instead of the 50 cents you would get if you only had invested your 100 dollars.
The risk lies in the amount of leverage that you choose to use. If the value of the currency you bought drops far enough that your margin (those 100 dollars) can’t cover any further drop you’ll be subject to a margin call, which automatically sells off your investment and covers the loss by draining your funds. If your 10,000 dollars with 100:1 leverage in a currency drops 1%, you’ll lose your 100 dollars, but if you went with a 20:1 leverage (so 100 dollars would only get you a 500$ investment) it would have to drop by 5% before you would lose your investment. That means much lower potential return, and much lower risk.
Free Instant Trading
Unlike the stock market, you don’t need to worry about brokerage fees in most cases. Additionally it’s all run instantly online, and the sheer size of the market means that there will always be someone ready to buy from or sell to you. That means that you can easily make a large number of trades and profit from small, short-term changes, or larger, longer term changes over days, weeks, or months. You can also, of course, make longer term investments, though that means a lot more time during which a sudden drop in value could destroy your investment, meaning that you’ll need a larger margin to accommodate those fluctuations.
Understanding how to manage your risk is the most important part of being successful on the foreign exchange market. Always set up a practice account before you work with real money to make sure that you understand what you’re doing.
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