Have you heard of Forex trading yet?  If you’ve been reading any type of finance blog or have followed any major investing site, you’ve probably seen the term come up a few times.  Forex trading is the trading of currencies worldwide, such as investing in the US Dollar, or the Euro, or even the Australian Dollar.  There are many different combinations to invest in, and here is the basics of what you need to know when it comes to Forex Trading.

What is Forex Trading?

Forex trading is a popular way to invest in currencies worldwide.  The currency market is the largest market by both asset size and liquidity, with trillions of dollars being traded every day.  It is used by central banks and companies to provide currency liquidity, but it is also used by individuals and investment firms worldwide to speculate in the value or currencies and on changes in interest rates in two currencies.

Forex trading is interesting because it trades 24 hours a day, worldwide, with no centralized marketplace.  This can be good and bad for individual investors, since price movements can happen at any time.  Forex trading also involves the use of leverage, which has the potential to increase gains, but can also cause larger losses.

How Do You Trade?

Currencies in the foreign exchange market are traded against one another in what is known as a currency pair.  A common pair would be the US Dollar and the Euro.  The first currency is considered the base currency, and it is quoted relative to the second currency, or counter-currency.   If the second currency moves in relation to the first currency, you realize either the gain or loss from the movement.

There is also the carry trade, which is one of the most popular trades.  The carry trade is based on the fact that every currency in the world has an interest rate attached to it.  The idea is that the trader goes long the high interest rate currency, and shorts the low interest rate currency.  By doing this, you profit on the spread in yield.