Forex, or FX, is an acronym for foreign exchange. What is forex? Generally speaking, forex is a global market where you can trade one currency against another, and profit from the fluctuation of prices of the exchange rates. These exchange rates always traded in pairs, like the EUR/USD for example.
It’s highly likely you’ve heard about this market, especially taking into account it’s the biggest market in the world. As a matter of fact, companies, banks, countries, and regular people take part in this market. Every time people buy something in a different currency, when we travel or buy something online, they take part in this mark.
How does it work?
Forex works similarly to stocks. While in the stock market people invest in a company, in the foreign exchange market the investment is in a country or region through the purchase of the corresponding currency. When people invest in an exchange rate or currency pair, they’re pitting the corresponding countries against each other. To put it differently, when we do so, we must try to understand which one is going to gain value against the other.
Since the forex market is a global decentralized market, it’s open 5 days a week, 24 hours a day. For this reason, it’s not transacted in a formal regulated market, like for example the NYSE. These transactions are made through a process called OTC, over-the-counter, where the main institutions are the FX brokers and act as the middle man in every order executed between market participants.
Now that you know what the forex market is, let’s talk about its advantages and disadvantages.
- Flexibility – The fact that it’s a market that is open 24 hours a day, 5 days a week, and possesses high volatility and liquidity, it allows for an abundance of opportunities for investors to make short, medium, and long-term transactions.
- Low costs – The low costs of transactions are already incorporated in the price, typically spreads are low thanks to high liquidity. The entry capital requirements are also very low, even though is not advisable, it’s possible to open a forex account with just 25$.
- Leverage – Most of the time, brokers grant their clients the use of leverage, which is a sort of loan that allows the investors to negotiate bigger sums of capital than the available in their account. In this way, it allows for possibilities of bigger returns.
- High risk – Like every kind of financial asset, the higher the probability of profit, the higher chance of loss. By using leverage, there’s a change of higher profits, but in an equal way, it also raises the chances of losses.
- Decentralization – Not having a regulated centralized market. This means the financial middleman gets to make its own market, where the regulatory control is sometimes limited.
- Difficult to master – FX market has, without any doubt, one of the steepest learning curves. Its high volatility translates into high unpredictability.
If we compare forex with investing in stocks and bonds, this financial instrument is difficult and more complex to manage, especially to the common investor. It requires solid experience in financial markets to skillfully deal with the high unpredictability and volatility, as well as good risk management skills. It has, without a doubt, usefulness to anyone who’s looking to expand its portfolio with an asset that allows for greater profits.
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