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The Forex Market: Risks And Rewards

Summary: This page has kindly been written for us by Investment-For-Beginners.com and looks at the forex market as a way of making money. It is worth pointing out that the risks in the foreign exchange markets can be considerable and this isn't necessarily a place for the risk averse or newcomer to try their hand in finance.

Many people are familiar with the stock market but completely unaware of the foreign exchange markets and all the opportunities that it can provide to individual traders.

The forex market has clear advantages over the stock market because it is a highly liquid market especially if you trade the major currencies such as USD, EUR, GBP, CHF. There will be always someone who wants to sell or buy the USD when you want to buy or sell it. Also in the currency markets, you canít lose more when the size of your trading account (though this could still be crippling). This is because your position is automatically liquidated by your broker as soon as it reaches zero.

Forex market runs 24 hours a day, five days a week. Such trading hours means that the currency markets are not based in a specific location. In fact, they are global and run 24 hours each day - somewhere - throughout most of the week. As might be imagined, it is a huge market that has trillions of dollars of transactions daily.

The trading size of a lot is 100k. This sounds out of reach to us ordinary mortals, but it is possible for individuals to trade. The use of margin trading - which is essentially borrowing to trade - enables an individual to take a position in the market for a small percentage of the total amount of the trade. This is made possible by using a forex brokerage .

The brokerage will effect the loan of funds for the trade and put in place a 'stop' to ensure that the trade is sold should a pre-set limit be reached. If, on the other hand, the position is to remain 'open' and the margin is used as the position loses money, a 'margin call' is made. This call is a demand for more funds to be made available by the client to keep the trading position open.

The speed and complexity of currency markets means that this is rarely a place to enter without significant preparation. While currency markets are massive and should - in theory - be too big to manipulate, this is not the case. The 'big players' include governments, sovereign wealth funds, hedge funds, investment banks and global corporations. Each of these can bring significant resources to bear which can in turn influence the market.

Possibly the best known example of this involves the investment and trading legend George Soros. In September 1992, on what came to be known as 'Black Wednesday', sterling was withdrawn from the European ERM (Exchange Rate Mechanism) and was devalued. Soros had been short selling the pound to such an extent that when the devaluation happened, he and his fund made a profit that is believed to be over US$1 billion.

Currency trading involves buying one currency when you believe it will increase in value and selling another when you believe that it will devalue. You can only buy one currency in terms of another as since foreign exchange rates are a relative measure of value between two. When you buy EUR, for example you have to 'pay' using another currency - in Forex this 'paying' means selling the currency. Therefore, currencies are traded in pairs.

While such swashbuckling stories of George Soros make the currency markets sound like a place where any individual can win, in reality this is not so. One needs to learn all the basics, have a tolerance to risk, risk capital available and the experience of months of paper trading (or demo trading) before entering this market. Therefore, this is a market into which a beginner should be very well prepared.

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