FOREX trading happens in the foreign exchange market. The investment strategy can be lucrative, but there are many risks to consider — making it the wrong investment for everyday investors.

Investing can open the door to a brighter financial future. But there are so many investment options out there, and the number of overly risky investments far outweighs the “safer” ones. 

The FOREX market is one of those risky investments you need to know about — mostly so you can avoid investing in it and losing serious cash.

What is the FOREX market?

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The foreign exchange market, or FOREX market, involves exchanging foreign currencies. 

You might already have some experience with exchanging currencies if you’ve traveled abroad. In which case, you’re probably aware that the value of your currency carries different values in different places. For example, you might find that your U.S. dollar stretches further in a place like Thailand, but won’t get you far in an expensive country like Switzerland. 

It is safe to think of the FOREX market as a much larger version of exchanging funds for your vacation abroad. But instead of trading currencies to purchase your sightseeing tickets, the goal is to speculate on the future price movements of a particular currency. 

As a large, global, and generally liquid financial market, FOREX sees constant price fluctuations based on innumerable factors from around the world. And with FOREX market hours operating almost constantly with different financial institutions worldwide, these price fluctuations seldom stop.

But FOREX investors hope to find a lucrative opportunity within this volatility to speculate on future currency prices. 

3 ways to trade in the FOREX market

The FOREX market is a big place. Every investor is trying to buy currencies they believe will rise in value and sell currencies that might lose purchasing power. But the way investors go about it will vary. 

The spot market

The spot market is the most popular foreign exchange market. Investors enact deals here in real-time based on the ever-fluctuating exchange rates. As the prices fluctuate, investors buy and sell currencies to capitalize on the opportunities they see. 

The forward market

The forward market involves privately executed deals between traders that enter binding FOREX contracts with other traders that specify an exchange rate for a specific amount of currency on a set date in the future. 

The futures market

Last but not least is the futures market, which is very similar to the forward market. An investor can buy or sell a predetermined amount of currency on a set date in the future. However, these deals are made on public exchanges instead of with private investors. 

FOREX terms to know

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Now that you have a better idea of what the FOREX market is all about, it’s time to learn the terms that you’ll encounter when navigating the foreign exchange market. 

Currency pair

When you make a FOREX trade, a currency pair is required. Sometimes a currency pair is referred to as a FOREX pair. Essentially, a currency pair illuminates the value of two currencies being quoted against each other. 

The first currency listed is dubbed the base currency, and the second in the pair is the quote currency. As an investor, you would make a trade of the base currency with enough of the quote currency. 

There are some major currency pairs that investors commonly trade within, including EUR/USD, USD/JPY, GBP/USD, and USD/CAD. But there are also some minor pairs out there, known as exotic pairs or exotic currencies. Typically, exotic currencies are pairs that include an emerging market. Also, a minor pair won’t have the U.S. dollar involved. 

Bid-ask spread

A bid is an amount that a buyer is willing to pay for the currency. An ask is the minimum amount that a seller will accept for the currency. The bid-ask spread is the difference between the two amounts. 

Lot

A lot is a standardized unit of currency that traders buy and sell. For example, a popular lot size is 100,000 units of currency. 

Leverage

Many traders cannot afford to buy an entire lot at once, so they utilize leverage to execute the trades. That means they borrow money to facilitate the transaction. Most traders that use leverage buy on margin, which means the investor will have to pay interest on the money they borrow. 

Pip

Pip stands for a percentage in points. The number indicates the absolute smallest price change possible within a currency pair. In most cases, a FOREX pip is 0.0001.  

What are the risks of FOREX trading?

As with all types of investing, FX trading comes with risks. But the risks involved in this type of investment opportunity are arguably more pronounced than more common forms of investing.

The increased level of risk starts with the fact that many investors will have to rely on leverage to make trades. That leverage can lead to a great windfall if things go as expected. But if the trade doesn’t turn out how you had hoped, then you may be forced to sell at a loss. 

Unfortunately, there is a high risk of losing money as an individual investor in the foreign exchange markets. Beyond the risk of losses, you’ll find that transaction costs can quickly eat into your trading profits. The constant price fluctuations and countless variables make it an unpopular strategy for average investors. 

Read more: How to determine your investing risk tolerance

What factors affect prices?

FOREX might not be the right fit for your investment portfolio. However, the foreign exchange market can still have a big impact on your daily life. That’s because foreign exchange markets can affect prices around the world. 

As with all markets, the basis of price changes in this market is due to supply and demand. But the demand for any particular currency may vary based on the economic policies, the interest rates, or the political environment of a country. 

The value of your currency may fluctuate based on trends in the FOREX market. As an average consumer considering a major purchase of an imported good, it can pay off to wait for an opportune moment when your currency has increased in value relative to the company making the good. Another reason to watch FOREX market trends is if you are considering a trip abroad. Keep an eye on the value of your currency compared to the value of the currency used in the country you intend to visit. 

For example, let’s say you are an American who wants to take a trip to Europe. It might make sense to hold off on your trip until you spot a favorable exchange rate that allows your U.S. dollars to buy more abroad. 

Who should trade FOREX?

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FOREX can be a great opportunity for investors with ample cash reserves and a high risk tolerance. Additionally, you should have time to commit to this skill set as you learn about the trading strategies, technical analysis, and technical indicators that affect the market fluctuations.

You should be prepared to lose on some investments as you learn the ropes of this risky strategy. But it is possible to make FOREX investing profitable for you.

Keep in mind, however, that if you don’t have the time to commit or the money to invest, FOREX might not be right for you. Generally, the average investor will likely not enjoy the FOREX trading process.

The good news is that there are plenty of other ways to invest out there! You just have to find the right fit for you.

Read more: 7 ways to start investing with little money

Summary

FOREX investing involves buying and selling currencies with the intention of capitalizing on the exchange rate. As the largest market in the world, you can find plentiful investment opportunities. However, there are financial risks that you should take into consideration before jumping in. 

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About the author

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Sarah Sharkey is a personal finance writer covering retirement, investing, debt, savings, credit cards, mortgages, and student loans. Additionally, she is the founder of Adventurous Adulting, a personal finance blog dedicated to helping readers tackle their money and take control of the adventure of life. You can connect with her on LinkedIn or Twitter.