Making a currency trade is becoming a more popular way for investors to diversify their trading opportunities. Currency trading involves selling one currency and buying another, with the expectation that the sold currency will go down in value and the purchased currency will rise in value.
But isn't a dollar always worth a dollar? Well, yes and no. A dollar has, on paper, the same value. But you know that a dollar today might only buy six eggs at the grocery store, whereas five years ago it bought an entire dozen. So the purchasing power of that dollar has changed--in this case, gone down.
A few years ago the value of a United States dollar against a Canadian dollar was about two to one: in other words, once you crossed the northern border and handed over your picture of Washington, you got two pictures of Queen Elizabeth II back. Today it's an even swap, one for one. So the value of those dollars relative to each other has changed. And that's how currency trading works.
In order to make currency trades profitable, of course, you've got to deal in amounts much larger than a dollar. And currency traders rarely, if ever, hang on to either currency involved for five days, let alone five years. A currency trade moves fast--almost instantaneously.
The value of various countries' currencies move up or down against each other every day based on a variety of factors. For instance, in the United States, if the Federal Reserve Chairman makes a speech, people may interpret some part of that speech as boding either well or poorly for the United States economy in the near future.
If the future looks strong, the value of the dollar may rise relative to other currencies. If the Federal Reserve Chairman gives a pessimistic speech, however, the future value of the dollar may fall. An informed currency trade based on this information can make the trader a lot of money in a very short period of time. Trading the wrong way, of course, can also lose the trader a lot of money.
Making a currency trade is not for the faint of heart or the ill-informed. You need to know what's happening now as well as what's coming up that might affect each country's currency. You need to have good instincts for when to open a position (buy a currency) and close a position, or sell.
In practice, most currency trades involve the buying of one currency and the sale of a different currency at the same time, because the entire transaction is actually an exchange. Starts getting a little more complicated, doesn't it? Now you've got to keep track of both currencies and how they're valued relative to each other.
How those currencies change in value during the time your position is open determines whether you make a profit or loss. Learning how to conduct a currency trade takes time and practice, but there are opportunities both online and in person for you to get a taste of the process. Most let you practice with "pretend" money, or a demo account, before you actually sink your hard-earned dollars into the market.
If you decide this may be an avenue for you, do your research. Learn the terminology, the risks and rewards, and the costs. Remember, you'll need a brokerage account and all the costs that go along with it. And don't forget to adjust for time differences, you West Coast traders! Forgetting about that can make three seconds stretch into three hours and three seconds, and your profit turn into a loss.
About the Author
frank j vanderlugt owns and operates http://www.lazytrader.com Day Trading
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