What is forex and why should sophisticated investors consider investing in the forex market?
The simple answer is you have probably used the forex market before, either directly or indirectly. Any time you take a trip to another country and exchange money, you just made a forex trade.
Whenever you buy something in a shop that was made in another country, you just made a forex trade. You paid in your own currency and the manufacturer was paid in a different currency.
Forex is a commonly used abbreviation for “foreign exchange.” It is typically used to describe trading in the foreign exchange market, especially by investors and speculators.
You may not know it, but forex is actually one of the largest markets in the world, with nearly $5 trillion in average daily volume transacted. This easily dwarfs the stock market. All the world’s stock markets combined average only about $84 billion per day.
The Largest Market in the World
The foreign exchange market, which is usually known as “forex” or “FX,” is the largest financial market in the world. Compared to the measly $22.4 billion a day volume of the New York Stock Exchange, the foreign exchange market looks absolutely ginormous with its $5 trillion a day in trade volume.
How does forex work? Imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. A forex trader in this situation will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.
A stock trader will buy a stock if they think its price will rise in the future and sell a stock if they think its price will fall in the future. Similarly, a forex trader will buy a currency pair if they expect its exchange rate will rise in the future and then sell a currency pair if they expect its exchange rate will fall in the future.
Forex trading goes on all around the world during different countries' business hours. Investors may trade major currencies at any time, 24 hours per day, five days per week, with a short weekend break. So if spikes happen in the after-market hours, investors may adjust or open trading positions immediately rather than waiting for the market to re-open the next day.
So with the above as prelude, here are five reasons to consider allocating a portion of your assets to forex:
1. For Capital Appreciation Potential
There's potential currency in investing in currencies. If the value of your currencies goes up against the dollar, you will see a profit. By contrast, if your currencies fall versus the dollar, you will lose money.
2. As a Hedge Against Political and Event Risk
The forex market also allows investors to hedge against world events. When interest rates change, tariffs increase or decrease, monetary policy wiggles, trade deficits widen or narrow, recessions happen, taxes increase or decrease changes, and more, investors can trade in forex to take advantage of currency price movements. For example, it you think that the dollar will drop in the future, you can buy one or more currencies that you think will rise.
3. As a Global Economic Hedge
There is a growing fear that current U. S. fiscal and monetary policies will generate inflation and weaken the dollar over time. Growing budget deficits, record low interest rates and the amount of money being created by the Federal Reserve are all reasons for concern, and these developments are being closely tracked by currency traders.The currency market allows you to select currencies based on how you perceive their relative values will change over time.
4. To Level the Playing Field
Because the foreign exchange market runs practically 24 hours a day, it's unlikely that any "inside" information could manipulate prices. Unlike stocks, the news that drives currency prices is available to everyone on a real-time basis.
5. As a Diversification Tool
Investors may also invest in forex to balance portfolios that may be over represented in more traditional in securities.
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain losses in excess of your initial investment. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.
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