Definition and Example of Forex Currency Traders
Forex traders use currency exchange rates to try to profit from trading foreign currencies. As currencies rise or fall in value in relation to each other, traders try to predict these changes and buy or sell accordingly.
For example, if you're a forex currency trader, you might focus on trading U.S. dollars and British pounds (GBP).
How Forex Currency Trading Works
The foreign exchange currency market, also known as "forex," is the world's largest financial market. More than $5 trillion is traded on the exchange every day—that's 25 times the volume of global equities. The majority of the world's currency is traded through this huge, highly decentralized marketplace. It has several trading centers, but the main ones are located in Tokyo, London, and New York, allowing the market to operate 24 hours a day, five days a week.
Currencies on the forex are represented by three-letter abbreviations, such as USD for the U.S. dollar, EUR for the euro, and JPY for the Japanese yen. Transactions are quoted in pairs such as EUR/USD.
The U.S. dollar is involved in just about every major currency pair, because it is the reserve currency of the world.
To understand how forex trading works, consider this example: Suppose the British pound (GBP) is quoted at $1.1510. This means that you could buy 1,000 British pounds for $1,150 U.S. dollars. If the asking price is $1.1511, we can see that the spread is relatively low—it's the difference between the bid ($1.1510) and the ask ($1.1511).
Suppose you buy 10,000 GBP at $1.1511. If the pound were to rise to a selling price of $1.1622, you may then decide to sell your position. Your profit would equal 10,000 times the difference between the price at which you bought ($1.1511) and the selling price ($1.1662), or $151.
Trading in foreign currencies is riskier than many other forms of investing and is not something in which just any trader should engage. With the chance of big profits comes the risk of huge losses, so it's important to understand how this market works before you decide to become a forex trader.
How to Become a Forex Currency Trader
There are three ways to trade foreign currency exchange rates:
- On an exchange regulated by the Commodity Futures Trading Commission (CFTC)
- On an exchange regulated by the U.S. Securities and Exchange Commission (SEC)
- In the off-market exchange (also known as "over-the-counter trades")
Once you know where you'll want to trade, you'll need to open a brokerage account. A few well-known U.S. forex brokers include:
- Thinkorswim by TD Ameritrade
- Interactive Brokers
Most large U.S. stockbrokers offer forex trading as well. If you currently have a brokerage account, you likely can begin forex trading through your stockbroker. In most cases, you simply need to fill out a short online currency-trading application. If you're opening a new forex account, you'll begin by making a small deposit.
Some brokers, such as FOREX.com, will allow you to open an account with as little as 100 of your base currency, though they may recommend you deposit more in order to have more flexibility and risk management with trades.
Once you've opened your account, you begin trading by selecting the currencies you want to trade. Currencies on the forex always come in pairs. As the value of one of the currency pairs rises, the other falls. Most beginning traders should trade only the most widely traded currencies, such as the U.S. dollar, the British pound, or the euro, because they tend to be the most liquid and have the smallest spreads. The forex spread is the charge that the trading specialist, effectively a middleman, charges both the buyer and seller for managing the trade.
Risks of Forex Currency Trading
As indicated in the example trade described above, currency trades are highly leveraged, typically by as much as 50 to 1, but in some countries they can be leveraged even more. That means you can use small amounts of money to buy currencies worth much more than what you're putting in. Beginning currency traders may be attracted to the possibility of making large trades from a relatively small account, but this also means that even a small account can lose a lot of money.
Forex traders can lose more than the value of their initial investment if they are not careful.
Another risk to consider is that the quoting conventions are not uniform. Many are quoted against the U.S. dollar, but there's no regulation or standard for quoting conventions in the forex market. Therefore, you have to know the specific meaning of the quotes for the currency in which you're trading, or you will risk losing money unwittingly.
And don't forget about fraud. Whether you're choosing to trade on a regulated exchange or in the off-market exchange, beware of any scheme that says you can get rich quickly.
Practice Forex Before You Start
One way to begin forex trading without any real consequences is to open a practice forex trading account. For example, FOREX.com offers a demo account, and Thinkorswim offers a virtual trading tool. Practice accounts typically open with a large amount of virtual money. This may help you learn how to trade forex without spending real money. If after a few dozen practice trades you see that you're trading profitably, you may try your hand at a real forex trading account.
- Forex currency traders buy and sell currencies on foreign exchange markets.
- They seek to profit from changes in different currencies' values in relation to one another.
- Forex trading can be highly profitable, but it also brings significant risk of loss.