Foreign Exchange 101: How to Invest in the FX Market

We’ve all watched movies that depicted the insane heat that goes on on the trading floor and you’ve heard terms like ‘foreign exchange market’ being thrown around. If you are interested in understanding what actually goes on, or you’re thinking of getting involved in the foreign exchange market, there are a few basics that you should get to know before you begin.foreign exchange market, there are a few basics that you should get to know before you begin.

What Is Foreign Exchange?

The foreign exchange market will sometimes be referred to as the currency market or even forex (FX) – but they all mean the same thing. It is the biggest financial market across the globe, with upwards of $4 trillion traded on average every day.

Investment banks, companies, central banks, investment firms, hedge funds and retail investors like you and me can all participate in the FX market – buying, selling and exchanging different currencies for one another.

Why Foreign Exchange Matters

The foreign exchange market lets different people and parties trade currencies. This means that multinational companies and businesses that need foreign currencies to pay for different goods or services delivered by suppliers from abroad can carry out the transactions they require. This helps generate economic activity and for trade to occur on a global scale. Some countries currencies are more traded than others and there are nearly as many currency pairs to trade as there are countries.

Most Liquid Markets In Foreign Exchange

The US dollar accounts for over 95% of forex trades in the market – for example the EUR USD currency pair trades in volumes above 1.2 trillion USD in the FX market daily. The entire forex market trades about $5 trillion per day.

How To Get Started In Foreign Exchange?

If you want to trade forex, you need to open a forex brokerage account. These days you can do all of this simply and quickly online – but it is still important to check that you open an account with a reputable broker that has a good track record. You should also check what the transaction costs are for buying and selling currencies with your broker before investing any money.

You can open a personal account in which you can make the buy and sell trades yourself from an online interface that will be part of your broker’s website. Alternatively you can have a managed account which means you let your broker makes your buy and sell trades for you – albeit under your instruction. Some brokers will ask that you deposit a minimum amount of money with them before trading but this can vary from broker to broker so it is worth asking in advance.

How To Invest In Foreign Exchange?

You can invest in the foreign exchange market in a number of different ways.

• Direct Investment: You can directly invest in the Forex market – which is 24-hour and trades currency pairs, such as the Euro/US dollar (EUR/USD) pair. In this market currencies are bought and sold according to the exchange rate.
• Futures: You can also invest in this market using futures contracts on the currencies. These contracts are bought and sold based on a standard size and settlement date and you can also do this online or over the phone with your broker.
• Options: Another investment option is foreign currency options – this contract gives you the right – but not the obligation – to buy or sell a fixed amount of a foreign currency at a specific price on or before a specific date in the future.

Although it is not complicated, before you start buying and selling futures and options you should do some research and speak with your broker to make sure you fully understand the financial product.

Exchange Traded Funds: A more practical and straightforward investment option is an FX exchange-traded fund (ETF). This will typically give you exposure to a variety of foreign exchange pairs without having to go through the hassle of buying and selling each one for yourself. An ETF also means experienced managers will select the FX pairs and will help you generate better returns and lower risk to your money.  Some ETFs are based on one currency only and manage a mixture of currencies.

What Can Foreign Exchange Do For You?

Trading in FX can be a great choice for you for a number of reasons. For example you may have an opinion that you want to turn into returns on your money. You might believe that the American economy is doing well and that the US dollar will strengthen compared to the Singapore Dollar. In this case you might want to buy USD and sell SGD.

• Lots Of Liquidity
  The great thing about FX trading is that there is lots of liquidity and you can get in and out of a trade quickly and easily if you want to.
• 24/7 Availability
  You can trade most major currencies at any time of day – 24 hours a day, 5 days a week. There are no set exchange hours for trading FX and this means there is something happening in this market at almost any given time of day or night.

• Low Trading Cost
  There are low trading costs in the FX market and this investment is an effective way for obtaining global exposure in your portfolio of investments. You may also need foreign currency if you are investing in another foreign asset – such as foreign stocks and the FX market facilitates this helping you to invest in global opportunities.

Of all the many currency pairs available seven are considered the most popular, the most traded and the most liquid. These are:

EUR/USD (euro/dollar) – known as “euro”

USD/JPY (U.S. dollar/Japanese yen) – known as  “gopher”

GBP/USD (British pound/dollar) – known as “cable”

USD/CHF (U.S. dollar/Swiss franc) – known as “swissie”

The above four currency pairs are dominant in the FX market with the following three a little less so:

AUD/USD (Australian dollar/U.S. dollar) – known as “aussie”

USD/CAD (U.S. dollar/Canadian dollar) – known as “loonie”

NZD/USD (New Zealand dollar/U.S. dollar) – known as “kiwi”

In all seven of these pairs, the US dollar is one of the currencies in the pair.

Read more on our foreign exchange analysis.