Forex is basically a cool short form of foreign exchange. So Forex trading is nothing but exchanging a country’s acceptable currency with that of another country’s acceptable currency.
Now to answer the question of how one makes money via forex trading here’s a very simple example: Say you are an American and wish to take a holiday to England. As USD isn’t an acceptable mode of transaction in England, you go to your nearest currency exchange dealer and exchange Dollars with the Pound sterling. In today’s exchange rate for $10 you get GBP 8.1 in exchange. So you took the holiday and contrary to your usual experience of running out of money then having to street perform to get money to reach home, you have some money left. While exchanging the Pounds you find that thanks to the ever fluctuating exchange rate you got $11 for the GBP 8.1 you gave back. So you earned $1 based on the relative pricing of each currency. This is how you make money via forex trading by speculating on the relative strengthening and weakening of currencies.
So as is the case, Forex trading is a lot like trading on the stock market except you are dealing in currencies and not stocks. And as is the practice you almost exclusively trade Forex online.
So to start you need to register with a broker and preferably use a demo account to practice Forex trading before putting in actual money and also check out the commission of the broker and the security deposit it asks. There are also certain terminologies one needs to be familiar with in order to trade like:
- Base currency: Currency you are spending let’s say USD
- Quote currency: Currency you are buying let’s say GBP
- Exchange rate: For one $1 how many GBP would you get
- Long position: Buy the Dollar and sell the Pound
- Short position: Buy the Pound and sell the Dollar
- Bid price: The price at which the broker will buy the Dollar in exchange of the Pound
- Ask price: The price at which the broker will sell the Dollar in exchange of the Pound
- Spread is the difference between the ask price and bid price
So whenever one is calculating their profit based on a currency’s price fluctuation one also needs to factor in the spread as the broker won’t buy the currency at the same price he sold you as that’s how he makes a profit to run the brokerage.
Now is forex trading safe and which broker to choose?
It’s a very legitimate way of transacting as as mentioned earlier whenever one exchanges currency one is partaking in a form of forex trading. If forex trading is legal in one’s country’s laws then the only way you can be swindled, is by your broker. So the key to not getting into trouble or not losing you money is choosing the right broker.
For the right broker:
- Check which is the host country of the broker that is where it domiciled. Getting domiciled in a country with a trusted financial infrastructure adds to the legitimacy.
- You should check if the broker is registered with a regulatory agency.
- Check out online reviews though they do stand a chance of being doctored.
- Visit the About Us page on the broker’s to know the financial stability and strength of a broker.
The most trusted brokers are:
- AVA Trade
- Plus 500
Now coming to the factors you need to consider in order to ensure your trade makes money. The currency of a country is almost always influenced by macroeconomic factors like:
- Economic growth rate: If a country has a high economic growth rate that is the country is growing and spurs investor confidence.
- Trade gap: If a country is running a trade surplus that is exporting more than its importing, there would be more people who have to buy it’s currency than sell it and it’s value increases.
- Political situation: If there’s a military coup or a war in a country then obviously the currency rate falls as people don’t really want anything to do with that country. If there’s an election coming there might be one candidate who is willing to encourage free trade, open up the economy for foreign investment which would spur the demand for that particular currency. If that candidate wins then you make money. There are other factors like a referendums like Brexit due to which the Pound lost a lot of value.
- Other factors: Other factors like interest rate, fiscal deficit, is a currency sector driven meaning is it influenced by the price of commodities like Oil also play a part.
So in the end should you do forex trading?
Making money off it is not as easy as it is in the stock market. You do need to invest a large amount or go seriously long term as there isn’t a huge fluctuation in a currency’s strength. For example the Indian Rupee traded wrt the USD at Rs 30 for $1 in 1991 and now it trades at about Rs 67 for $1 in 2017. One can definitely make money in forex but there just isn’t much for the average investor as the process is a bit complicated.
Plus there are also other ways to make money in Forex one of which is arbitrage. That is suppose a product is selling for $1 in a market A and $1.1 in another market B. You can buy that product at A and sell it at B. In forex trading the same opportunity can arise but it usually occurs when one trades over multiple currencies. That is if you trade currency A to B then B to C and then C to A and create a triangular arbitrage there might be a scope for you to exploit the price difference. One is usually alerted about this via a software but these arbitrages occur for a very short amount of time and have a very low margin.
Considering all this, is it worth it? The answer is yes if you are smart at economics, have practiced Forex trading using a dummy account long enough, observed the trends and kept your eyes and ears open or in short if you are a professional with loads of experience. For the rest, the stock market does ensure a long term, more sustainable return as compared to the Forex market.