For some traders and investors, investing in a foreign currency offers an exciting opportunity to speculate on the exchange rates between currencies around the world. While it is risky, many can walk away with a profitable foreign exchange, also called forex or FX. If you are new to investing in foreign currencies, here's what you need to know to get started.
What Is Forex Investing?
When you travel around the world, you can't always use U.S. dollars for purchases. Instead, you have to convert your money into euros, yen, pesos, or whatever currency is used by the country you are visiting.
When buying or selling money to travel, you probably noticed the exchange rate. This tells you how much of the other currency you get per dollar, and vice versa. These rates change regularly. The price changes are based on economic news, projected economic data, and other factors.
In forex trading, you buy a large amount of foreign currency just like you would buy a stock, bond, or mutual fund. Instead of trying to earn a profit through the value of that investment going up, you hope the U.S. dollar value of that currency will move in the direction you're hoping for (up or down). When it does, you earn a profit when converting the currency back into dollars.
Further Reading>> How to Invest in Stocks
What to Know Before You Invest in Forex
Before investing in forex, it’s important to understand the risks involved and how you plan to profit. Going in without a well-defined strategy can lead to poor execution and big losses. Here are some important things to keep in mind before you make your first forex investment:
- Investment risk: Start by getting an understanding of your overall investment risk. The risk profile of USD/CAD is very different from USD/BRL. Just as every company is different in the stock market, every currency pair is different in the forex market.
- Trading fees: Some brokerages hide fees inside of spreads, or the difference between buying and selling prices for a currency pair. Others charge clear transaction fees based on volume, trade size, or pair. Know what you’re going to pay for every trade.
- Leverage used: If you’re exposing yourself to more than $1 of risk for every $1 invested, you’re using leverage. This can accelerate both gains and losses, so know how much leverage you’re using.
- Margin requirements: Similar to leverage, margin can lead to outsized profits and losses. If you’re trading with margin, understand the costs, and know the margin requirements for your account.
- Profit or loss per pip: Currencies go up and down in small increments, known as pips. Know the amount you will make or lose in dollar terms per pip in exchange rate change.
- There’s no centralized FX market: Every forex trading platform operates its own marketplace with its own rules and fees. The exact rate you get may not be the same spot rate paid by large banks or published on forex news sites. You pay a rate based on your platform’s own market activity.
Steps to Invest in a Foreign Currency
Here are the steps to invest in foreign currency:
- Open a brokerage account — First, you need a place to hold your foreign currency. That's a brokerage account. Open one to get started if you don't already have a favorite brokerage. We recommend using one of the following discount brokers:
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- Fund your account — Deposit cash from a linked checking or another brokerage account.
- Research your forex strategy — You shouldn't just go buy pounds, loonies, or yuan based on a gut feeling. Research the economic outlook and make an educated currency purchase.
- Enter a buy order for your favorite currency pair — Once you pick your currency, choose the right asset type (option/future/other) and enter your trade.
- Keep tabs on your investment — Forex markets can change very quickly, often even faster than stocks. Keep focused on your investments and be ready to make a move if they take a turn in the wrong direction.
Types of Foreign Currency Investments
While you can buy and sell foreign currency directly, many traders use different tools to invest in currencies. Here are a few popular methods to get into forex trading with a brokerage account:
- Options — Currency options give you the ability to buy or sell currency at a set price at a specific date and time. If the specifics work out in your favor, you can exercise the option for a profit. Learn more about options trading here.
- Futures — Futures work like options in many ways. But instead of having the option to exercise at a set time, you are obligated to exercise the contract when it's up. Learn more about futures here.
- Funds –Mutual funds and exchange-traded funds (ETFs) often hold stocks and bonds, but they are not limited to those assets. A fund can also hold foreign currencies. Learn more about investment funds here.
Some investors may use one of these investments as a hedge. Currency hedging is a combination of trades designed to offset other risks. It may also be useful for expats who want to keep accounts in multiple currencies.
You could also get the currency directly from your bank in some cases. And some online banks allow you to hold foreign currencies. Forex is riskier and more complicated than some other types of investments, so your options here are a bit more limited than with other asset classes.
Risks and Advantages of Investing in Forex
Foreign currency investing can be exciting, but it isn't for everyone. Before getting started with forex, it's a good idea to look at the risks and advantages of this type of investment.
Advantages of Investing in Forex
- Diversify your portfolio — Many investors focus heavily on stocks and bonds. Forex is a popular alternative to diversify your portfolio.
- Profit on international economic news — News and statistics enthusiastic can develop trading strategies around news releases, elections, and other current events.
- Trade around the clock — Unlike the stock market, which has fixed hours, forex markets are almost always open somewhere. Some forex platforms support 24-hour trading, so you never have to wait for the markets to open.
Risks of Investing in Forex
- High volatility — News travels fast among forex traders, and these markets tend to move quickly. Forex markets are often more volatile than stock and bond markets.
- Less predictable markets — When investing in U.S. stocks, you can count on company guidance, financial reports, and other data to predict the future. Forex markets can take big swings with less warning.
- Many bad investment options — Investor Junkie recommends working with reputable companies to manage your portfolio. There are some bad players in the industry that offer poor products with extremely high risk, which can be made worse with margin trading.
What You Need to Invest in Foreign Currency
To buy or sell foreign currency, you need a brokerage account that supports this type of asset. If your broker doesn't allow you to invest directly in foreign currency-related options or futures, most support a wide range of ETFs and mutual funds that give you FX exposure.
We've already said it, but it's important to emphasize that foreign currency investing is very risky. You need to fund your account to get into the forex. Make sure it is money you can afford to lose if things don't go as planned.
Enter the World of Forex With Care
Forex is an exciting place to invest, but it's a more expert area of the investment landscape. Newer investors should start with less risky assets before dabbling in currencies.
Like every investment, there are risks and rewards with forex trading. You should look at all of your options before deciding. To try out forex without risking any real money, look for a brokerage with paper trading, which works like a stock market game. Once you feel comfortable, head to your favorite brokerage to get started.