Foreign exchange (Forex or FX for short) involves the buying and selling of the major currencies found around the world.  The salient currencies most often traded by Forex participants include the U.S. Dollar, the Euro, the Japanese Yen, and the British Pound.  Each currency is valued against another currency; this is no different than what you see at a typical currency exchange shop while on vacation.

This one-on-one currency valuation is termed a “swap.” A Forex trading swap is simply understood by thinking in terms of how much of one unit of a currency can be swapped for another currency.  For instance, how many Japanese Yen can be bought for one U.S. Dollar?  To use round numbers for this example, assume the current quote on that swap entails one U.S. Dollar being worth 100 Japanese Yen.

If you trade Forex utilizing a Dollar/Yen swap, you can invest with one of two theses.  You can trade hoping the Dollar decreases in value against the Yen.  In this scenario you are “long” the Yen against the Dollar. Conversely, you can trade with the goal of the Dollar increasing in value against the Yen.  In this instance you would be “short” the Yen against the Dollar.

Analyzing the first scenario, assume you invested $100 going long the Yen against the Dollar.  Assume further that the Dollar/Yen exchange rate dropped from 100 Yen to the Dollar to only 90 Yen for one Dollar.  You essentially purchased 10,000 Yen on your initial trade ($100 invested purchasing 100 Yen for each Dollar).  Now that the quote has moved to 90, you are able to exit the trade redeeming your 10,000 Yen for $111.11 USD.  Consequently, you made $11.11 profit on this Forex trading transaction.

When you are “long” one currency against another, your hope is that the currency you own improves in value against the one on the other side of your swap.  Alternatively, when you are “short” one currency against another, your goal is for the currency you are short to decrease in value.  Hence, with Forex trading you can effectuate trades to capitalize on either projected strength or weakness of any major currency as quoted against any other major currency.

Valuations within the Forex trading universe change by the second.  This volatility allows for quick profits for Forex traders who are able to adeptly move in and out of various positions.  Today’s best traders are armed with sophisticated trading and execution programs, which give them a leg-up against the strong competition within the Forex trading environment.

Additionally, most of these programmed Forex trading vehicles allow for practice accounts, which allow new participants to formulate and refine their strategies without risking real money.  Those who have tired losing money to CEO scandals and irrational stock market events should explore removing those uncertainties by transitioning away from stocks in favor of trading Forex.

Good Forex trading strategies will yield results over the course of time.  Within a given day’s, week’s or month’s trades, anything can happen.  Smart Forex traders understand this and devise money management parameters that allow them to absorb temporary adverse results retaining sufficient funds to remain in the game.  Money management often proves to be the most critical factor within an overall Forex trading strategy.

A good initial rule of thumb is not to risk more than 3% of your entire account value on any one trade.  As you progress within the Forex arena it is acceptable to increase this threshold to up to 7%.  However, until you develop a higher level of expertise, it is advisable to strictly remain within this 3% limit and avoid the temptation to exceed it no matter how attractive any one Forex trade opportunity appears.

By limiting your exposure for loss to 3% of your portfolio from any one bad trade, you are able to have staying power and emerge from inevitable bad streaks fully able to capitalize on the good streaks, which are always sure to come.  Reckless new participants often risk too much, and after just a few initial bad trades, see their account balance depleted.  Ensure you do not fall victim to this scenario.

The next aspect of money management relates to what is termed as “leverage.”  In Forex trading, leverage can be either your best friend or your worst enemy.  To understand leverage, think of a traditional home mortgage.  Assume you are buying a house for $300,000.  You put down $60,000 down payment and borrow the other $240,000 from the bank.  Further assume you sell this house for $360,000.  You made $60,000 profit, and it was done with only investing $60,000 of your own cash.  This represents a whopping 100% ROI (return on investment).

However, assume that you paid for the house in cash.  In this scenario your $60,000 profit would be return on invested cash of $300,000, thus representing a much lower 20% return on investment.  The same exact phenomenon occurs in Forex trading; however, the levels of leverage that can be employed are much greater than seen in home mortgages.  In Forex trading, some accounts allow you to lever 400:1.  This means you can buy $400,000 worth of a given currency while only investing $1000 of your own cash.

In this scenario, the smallest of gains in the currency you bought can translate to huge profits.  A 1% movement would yield $4000 in profits coming from only a $1000 cash investment.  However, it is critical to analyze the other side of the equation.  A .33% movement to the downside would cause immediate loss of your entire $1000 investment.  Both gains as well as losses are magnified when using leverage.

New Forex traders are strongly urged to use leverage sparingly on initial trades.  Many Forex trading software packages have built in limiters to prevent you from creating too much exposure from any one given trade.  Before you make that first Forex trade, make sure you have fully thought out your money management plan

Fundamental Analysis, as its name suggests, involves scrutiny of the core underlying fundamental factors that impact the worth of a nation’s currency.  There is a long list of these factors, with the primary ones being inflation, unemployment, money supply and GDP.  Take for example a country’s money supply.  The law of supply and demand dictates that when there is more of something, then it is worth less.  If a country prints a large amount of money, then its value as gauged against other currencies will go down.

Fundamental Analysis requires both a deep degree of understanding of macro-economics, along with close attention to developing world economic events.  Political events, natural disasters and the foreign policy of a nation can also dramatically affect the valuation of a currency.  There is no quick money to be made using Fundamental Analysis since the various forces underlying fundamental currency valuation take a long time to play out.  Forex traders relying upon Fundamental Analysis need to be able to hold their positions for months, if not longer.

The second category of “Technical Analysis” does not take into consideration any of the macro economic or political factors upon which fundamental analysis rests.  Forex traders using technical analysis attempt to profit from quick short-term movements of currencies.  These second-to-second movements are not driven by tangible events.  Technical Analysis seeks to notice patterns and signals which, according to past occurrences, portend to a high likelihood of a future event happening.

Technical Analysis relies heavily upon the ability to read charts outlining recent movements of a currency and notice a pattern, which indicates a probability that the currency will move a certain way as it historically has after the given chart pattern emerged.  There are myriad patterns that have been quantified to be either a bearish (bad for the short-term prospects of a currency) or bullish (good for the short-term prospects of a currency) indicators.  The trick is to be able to quickly notice that a pattern or signal has occurred and rapidly act upon it.

The most sophisticated Forex traders have realized that Forex trading software is able to both track fundamental developments, as well as vigilantly be on the lookout for either bullish or bearish signals and patterns.  The human mind can only process so much information at once.  Forex traders who attempt to manually trade often end up missing the brief window that a good technical indicator presents.  Now that the prices associated with even the best of these Forex trading software packages are within anyone’s range, there is no excuse for trying to go it alone in your quest to conquer the currency market.