Most of the currencies in the world are valued the same way that any consumer product is: by the principle of supply and demand. When you swap one currency for another through the Forex (foreign exchange) system, you are essentially buying that currency.
Economic conditions change and this drives the value of currencies up and down in relation to one another. If, for example, it suddenly becomes desirable for businesses to outsource to Japan, corporations will start buying up Yen to expand their business in that region. This drives up the price of Yen.
Forex traders can take advantage of this by investing in the currencies themselves. Instead of buying Yen to buy products or services in Japan, they buy Yen in the hopes that they can later sell it for a profit.
One of the reasons so many people enjoy trading Forex is the fact brokers are willing to leverage enormous sums of money. Currencies are relatively stable, without leverage gains losses would be tiny in the vast majority of cases.
Where stock brokers will typically only leverage about twice as much money as you invest, Forex brokers will often be willing to leverage over a hundred times the capital you are willing to invest. In other words, a 1 percent shift can double your investment.
Of course, it can also cause you to lose it all.
The Most Important Thing You Should Know
By far the most crucial element of any Forex strategy is called a stop loss. A stop loss is a point where you automatically sell your currency and get out.
We live in a global economy, so people are buying and selling currency at all times, even at times when the economic future is incredibly uncertain. This makes Forex the most liquid market in the world, and it is almost always possible to sell your currency at any time.
A stop loss prevents you from experiencing immense losses as a result of the incredible amount of leverage on the Forex market. Even better, if your investment has already increased in value, you can use a stop loss to lock in those gains and virtually ensure a profit no matter what happens.
Forex Secret: The Trailing Stop
Perhaps even more helpful than the stop loss, a trailing stop is actually a special type of stop loss. A trailing stop automatically sets a stop loss a certain percentage below the maximum value of your investment.
For example, suppose that you set a trailing stop of 0.1 percent. If you were leveraging your investment 100 times, this would initially prevent you from losing more than 10 percent of your investment.
If the value of the currency you were investing in rose by 1 percent, this would increase the value of your investment by 100 percent. The trailing stop would then be adjusted to automatically sell your investment if the value of the currency fell back down by 0.1 percent, guaranteeing at least a 90 percent return on your investment.
If the value of the currency increased by 2 percent from your initial point of investment, you would then be guaranteed at least a 190 percent return on your investment, and so on.
Forex is appealing because of the high leverage and liquidity of the market. A well chosen stop loss or trailing stop and the advisement of a skilled financial expert can make this a great opportunity for those willing to accept some risk of well defined losses. Sudden fluctuations in the market can potentially earn you a great deal of money overnight, which makes this a very attractive option.