Forex Trading - Currency Trading vs Stock Investments



The title points up an important difference between forex and stock investing.

When buying stocks you're making an investment in a company. Buying shares is short for 'purchasing a share of ownership'. By contrast, no one is making an investment in Japan by buying yen. We leave aside politically motivated actions by large central governments. Currency is exchanged in order to facilitate the movement of goods and the payment of services between multiple countries, but that's a relatively small percentage of the total $2 trillion daily volume. The largest amount is simple speculation.

Well, perhaps not very simple. Trading euros against dollars against yen against pounds against... in a twenty-four hour market with a dozen time zones... it gets complicated.

Margin differences between the two markets are enormous. Most stock brokers will leverage (lend investors money) up to 2:1. In currency trading 100:1 is common. Since price movements occur twenty-four hours per day every day, margin calls can occur while the investor is sleeping. That makes for a bad awakening.

Trading cycles are generally much shorter. Stock investments are made, even by professionals, on timelines of months or years. Currency trades are often completed within a day or even minutes. Yes, that happens in the equities markets, too. But, it isn't the norm even though it's more common than ever.

All these differences suggest some lessons for the investor interested in forex trading.

Do your homework.

Be aware of factors affecting currency rates. That includes not only the standard domestic economic indicators, but trade imbalance figures, central bank policy changes and others.

Watch the market.

Small, rapid changes can force your position into an area that motivates your broker to execute a margin call. Be prepared to cover your position or liquidate at times favorable to you. Know the broker's margin call policy and practice. You'll be required to sign a margin agreement when opening an account. Read it first.

Practice.

When starting out, take advantage of the demos offered by most brokers. Execute paper trades - trades that don't execute on the real markets - using the real currency figures.

Get a feel for the amounts, the percentage changes and get used to converting currencies from one country to the next. You should be able to estimate without much thought how much 1,000 pounds is in dollars at the current exchange rate.

Opinions and size don't matter.

Unlike stock markets, the size and complexity of the forex markets makes it virtually impossible for any investor, no matter how large, to dominate the price. Program trading, fund trading and so on that can cause large movements in particular equities has a negligible effect on currency prices.

Similarly, analyst projections have much less influence in currency trading. Many will read eagerly some influential columnist's opinion of the future of IBM. Opinions of that kind are largely discounted in currency trading.

It's a different world out there.

There are around 4,500 stocks listed on the NYSE and 3,500 on NASDAQ. And many more on other exchanges. A few hundred are major players. By contrast, only a dozen currencies account for 99% of all trades. With four major markets trading twenty-four hours per day, the action is very concentrated.

No need to be intimidated though. Currency trading has moved in the last decade from the realm of the professional trading millions at a click to mini-accounts of $250.

So, go make some money.