Why Invest in Foreign Currency?
Opportunities in the forex market continues to attract capital from both institutions and retail investors. The current world-wide economic crisis has resulted in a serious erosion in the value of virtually every type of traditional asset class (i.e. stocks, bonds, commodities, real estate) with the one notable exception: currencies. Why?
Ability to profit in rising and falling markets
During times of uncertainty and adverse economic conditions, investors can profit from the movement in the exchange rate differential between the traded currency pairs. Investors profit from the fact that one of the sides of the pair is always gaining, provided the investor picks the right side of the trade.
High volume and liquidity translates into easy entry/exits on trades
The major currency pairs always have buyers and sellers. Unlike many high yield investments which can be difficult to sell, Forex investors never have to worry about being “stuck” in a position due to lack of market interest. With the market open 24 hours a day, investors can react to news when it breaks, rather than having to wait for an opening bell when everyone else has the same information.
Higher leverage makes funds work harder
Forex provides more leverage than stocks or futures. On a daily basis, the volatility of the major currencies is less than 1%. This is much lower than an active stock, which can easily have a 5-10% move in a single day. With leverage, a trader can capture higher returns on a smaller market movement. More importantly, leverage allows traders to increase their buying power and utilize less capital to trade. It should be noted that leverage can work against the trader as well resulting in substantial losses if not managed properly.
How the Market Operates
Forex trading follows the sun around the globe through the inter-bank market, a global group of commercial prime banks that deal with one another on a continual basis. It is an electronic network on which trading is not centralized on an exchange, as with the stock and futures markets. This 24 market begins in Sydney, continues through Tokyo, Hong Kong, Singapore, then on to the European continent in Zurich and London before moving to New York. The market is constantly reacting to currency fluctuations caused by economic, social, and political events. Essentially unregulated, the Forex market is influenced by governments through their countries’ central banks. Each country has policies governing its currency which can affect trading. Currencies operate as tradable commodities according to the principles of supply and demand, so there is always an opportunity to profit. The best trading opportunities are with the most commonly traded (and therefore most liquid) currencies, called "the Majors." Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.
Over $3 trillion worth of foreign currencies trade every day making it the largest market in the world - larger than all of the stock markets combined. According to the BIS, average daily turnover in traditional foreign exchange markets is estimated at $3.21 trillion. "Foreign Exchange" is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, such as the Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY). Governments, banks, international corporations, hedge funds, and individual investors exchange foreign currencies on this 24-hour inter-bank market. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation. From 2002 to 2009 the practice of trading forex has seen tremendous growth and this growth curve is expected to continue rising as investors seek to take advantage of the opportunities this popular alternative offers.