What Is FX Trading

First lets discuss what investments in foreign exchange means. It doesn't mean purchasing abroad currency and saving it up until it fairs well in rate. Exchanging the money you own and holding it till it rises in rate can take you only so far, ordinarily you may win about a couple of dollars over a period of an year by doing that. Then what does it stand for? It signifies actively trading in currency in a abroad currency market or and change.

Before going into details, let's notice how a Forex market really works. In Forex markets there is no concept of buying a currency, there is always an convert of currencies, one being purchased and the other being sold-out. Lets take this to a phase that we are all comfortable with; You'd ordinarily 'purchase dollar marks', but what we actually do is convert the local currency we have into USD at the present-day market value. Lets assume the dollar is at 105 local currency units nowadays, we'll spend 210/= and buy 2US$ and will keep the dollars with us. If the dollar grows to 110/=, our investment has as well appreciated. To take use of the appreciation, we have to re-sell the dollar at 110/= and we would have taken a profit of 10/= on the dealing. Now look at this from a strictly external point of view. Intially the investor pays out some currency to buy another sort. Then when the rate rises up, he trades what he in the first place bought and buys back the deprecated currency. The difference in the rate he bought at and sold at, is his gain.

In a FX market, you'll trade something thats called a currency pair. This will look something like EUR/USD. If you buy this, you will actually switch over the USD that you have with Euros. When you've bought a currency pair, its called opening up a position. But just because the Euro moved up, you can't benefit from it. You have to switch it back to the original USD to equate the profit. So how would you do this? You have to change the EUR you have to USD, i.e. you close the position that you opened. Let's take an example: In current market the value of the EUR/USD is about 1.57 i.e. each Euro is valued 1.57 times the USD. Lets say you have 157 USD, you change this for a 100 EURs (i.e. you open a position by buying the EUR/USD pair). Tomorrow, the EUR/USD rate might turn out to be 1.5730, the EUR has gained somewhat. Let say that you close the position now, you have 100 EURs which converts to 157.30 USD, you've gained 30 cents on your investment. See? pretty simple.

You may ask how this is any different to purchasing abroad currency and holding it till it rises. The cause is because with a bank, you can only switch over the LKR with the majors (USD, EUR, JPY, GBP). Lets say the Dollar started appreciating against the GBP; you really can't do anything about it. (eg: USD is say 105/= and say GBP is somewhere around 200/=, you have LKR with you and all of a sudden USD starts out going down all the way to 100/=. The effective rate of GBP/USD at the beginning was 1.9047 at the end of the event, the rate is 2.00. If you could trade the GBP/USD pair, you could have made a profit on this. But you cant because you have only LKR. Well yes, you could switch the money to USD and then to GBP and wait till it rises and ... bit of a work yes?) In a forex dealing place, the transition will automatically done for you; You can deposit your money in USD and in reality switch a pair like EUR/JPY.

If you're looking for more information, take a look at What Is FX Trading.