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Investing in Foreign Currency: The Basics

The lure of investing in foreign currencies via the foreign exchange (forex) market can be tempting for investors who are looking for an additional way to grow their income, but it can also seem like an out-of-reach goal for someone who is just starting out. The advent of online brokers and tools has brought forex beyond the traditional institutions that used to dominate the market and into the realm of an investment option for upcoming investors. If you’re interested in getting involved in forex trading, here’s a brief guide to the basics to help you get started.

Understanding the Forex Market

The foreign exchange currency market is known as the largest investment market in the world, with an average daily turnover of more than $5 trillion. To put that into context, the New York Stock Exchange only has a daily volume of about $50 billion. The market is open 24 hours, but most trading is done within the three primary daily sessions – European, United States, and Asian. Currency is traded in lots. A micro lot is worth 1,000 units ($1000), a mini lot is worth $10,000, and a standard lot is worth $100,000. You can study sites like InvestinGoal.com to learn more about how the market works in detail.

What Are Pips and Pairs?

In the forex market every trade is done in pairs – when you sell one currency you have to buy another at the same time. Currency prices are represented down to the 4th decimal place, making the smallest possible trade increment a “pip” – 1/100 of 1% of the lot.  Thus, in a micro lot a pip represents $0.10, in a mini lot a pip represents $1, and in a standard lot a pip represents $10. Currencies can move by only a few pips or by as much as 100 pips in a single session, so beginning investors tend to stick to trading by the pip within micro lots.

The Most Commonly Traded Pairs

Unlike the stock market’s broad selection of investment opportunities, the forex market only has 18 currency pairs to choose from. Of those, the 8 most commonly traded currencies are:

  • US Dollar (USD)
  • Canadian dollar (CAD)
  • Euro (EUR)
  • British pound (GBP)
  • New Zealand dollar (NZD)
  • Australian dollar (AUD)
  • Swiss Franc (CHF)
  • Japanese Yen (JPY)

Studying how to trade the most common currency pairs and starting small is the best approach for a novice investor who wants to start trading with minimal risk. While forex trading isn’t necessarily easy, many believe it is simpler than the stock market because there are fewer options to consider in your daily management practices.

Studying the Factors that Move Currency Values

In very basic terms, the value of currency is most affected by the principal of supply and demand. For example, when the demand for USD increases, the value goes up, but when the supply of USD exceeds the demand, then the value of that currency goes down. Of course, there are other factors to consider such as economic reports, interest rates, and geopolitical events. Ultimately, the only way to get good at forex trading is to dive in and gain some experience with a demo account from a reputable broker.