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Foreign Exchange Trading

Foreign exchange trading relies on the strength of currencies to turn a quick profit.

Foreign exxchange trading is closely monitored worldwide. [©Jupiter Images, 2009]
©Jupiter Images, 2009
Foreign exxchange trading is closely monitored worldwide.

Foreign Exchange Trading

Foreign exchange trading occurs when people trade the currency of one country for that of another. The trading occurs in the foreign exchange market, which is also known as the FX market, according to the Federal Reserve Bank of New York. Brokers and online Web sites have enabled individuals to become involved in foreign exchange trading. However, foreign exchange trading is a speculative investment that comes with risk. While the foreign exchange market is the largest financial market in the world, it is also very volatile.

The Foreign Exchange Trading Market

Foreign exchange trading involves transferring funds from one country's currency to another country's currency. The exchange rate is the number of units of one currency that buys one unit of another. This is determined by market fluctuations and participation. The exchange rate may be influenced by politics, the stock market, inflation, government policies and business cycles.

The foreign exchange trading market is a global trading network without a central headquarters. Instead, the trading occurs over the phone or electronically. Three countries handle most foreign exchange trading: The United States, Japan and the United Kingdom. Other countries involved in the market are Singapore, Switzerland, Hong Kong, Germany, France and Australia. Some countries do not allow their currencies to be traded. Foreign exchange trading occurs 24 hours a day. In 2007, the U.S. dollar was traded most in the foreign exchange market. International Financial Services London explains that the foreign exchange trading market is the most liquid financial market in the world and is also undergoing rapid growth. Between 2004 and 2007, foreign exchange trading rose 70 percent. About $1 trillion in currencies are traded every day in the foreign exchange market.

Types of Foreign Exchange Trading

Foreign exchange trades can be structured in different ways. The most common types include:

  • Outright contracts. These involve a direct exchange of one currency for another. 
  • Foreign exchange swaps. One currency is swapped for another and then swapped back on a pre-arranged date. 
  • OTC (over-the-counter) currency options. These options give the holder a right to buy or sell a currency at a specific price within a specific time frame.

Foreign Exchange Trading Participants

Participants in foreign exchange trading generally include the following:

  • Banks and financial institutions. The biggest participants, banks and financial institutions earn money when they buy and sell currencies to and from each other. 
  • Brokers. The bridges between banks, brokers earn a commission and suggest the best prices for currencies. 
  • Customers. These are mostly large companies that need foreign currency to do business. The public may also be involved in foreign exchange trading. 
  • Central banks. These banks work for governments and try to shore up their country's currency by participating in the FX market.

 

Some foreign exchange traders try to earn short-term profits as exchange rates shift. Others attempt to protect themselves from losses as exchange rates change.

Foreign Exchange Trading Scams

The U.S. Commodity Futures Trading Commission warns that the U.S. government has seen an increase in the number of foreign exchange trading scams, which are also becoming more complicated. Foreign exchange trading scams are most often committed by:

  • Unregulated firms that sell foreign currency futures and options contracts to the public 
  • Registered firms and affiliates

 

The government warns the public to be concerned when foreign exchange trading promoters claim the customer will earn high profits with minimal risks. According to Crimes of Persuasion, scammers may ask individuals to give them a margin, a sum of $1,000 to $5,000. The investor is not aware that margin trading may result in him or her having to pay more money than the original investment. They may also have to pay a 50 percent commission on each deal, making it impossible to earn a profit.

Individuals should also be suspicious of the following:

  • Companies that solicit them
  • Companies or individuals refusing to provide background information
  • Companies that target minorities
  • Companies or individuals promising little risk
  • Companies that make high-pressure sales presentations


Before trading, the government recommends that an individual:

  • Establish expectations, goals, and determine how much can be lost
  • Understand what commodity futures and option contracts are 
  • Understand exposure to risk
  • Understand what it means to trade on margin

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