What is forex and what are the potential benefit - and drawbacks?
Forex is a commonly used abbreviation for "foreign exchange." It is typically used to describe investor trading in the foreign exchange markets. The Forex market is one of the largest in the world, with approximatly $5 tillion in assets traded daily.
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 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. 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.
The nearly $5 trillion forex market is both decentralized and electronic - from Hong Kong to London to New York. Foreign and domestic stock markets and futures markets are housed in central physical exchanges,
Because of the liquidity available in the forex market, you can trade forex with considerable leverage, up to 10:1. This provides investors the potential to benefit from the smallest market moves. Leverage is a double-edged sword, of course; it can significantly increase investor losses.
As the world becomes more and more global, investors hunt for opportunities anywhere they can. When investors invest in another country, or sell it short, forex may be a way to gain exposure while avoiding vagaries such as foreign securities laws and financial statements in other languages.
Long or Short
Unlike many other financial markets, where it may be difficult to sell short, there are no limitations on shorting currencies. Investors can potentially generate gains or losses at any time.
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