While most of us only ever think about foreign exchange rates when we're queuing at the bureau de change or planning holidays abroad, some UK investors are tempted to try their hands at trading currency markets online. But for the unwary, gambling on foreign exchange carries a risk of making big losses.
The problem with forex – and one of its major attractions – is that investors allow you to leverage the money they place. In effect, that means you need to deposit only a fraction of the value of your trade to open and maintain a position, usually between 0.5 and 1 per cent.
"In forex trading, a small deposit can control a much larger total contract value," says Michele Lewis, a spokeswoman for eToro, which has just relaunched its foreign exchange trading software platform. So if a broker offers 200-to-one leverage, a $50 margin deposit lets you buy or sell $10,000 worth of currencies. With $500, you could trade with $100,000.
But leveraged trading in a fast market can mean you can lose big. New traders can be easily caught out by the speed of the market. The better forex brokers provide a range of risk management tools, such as an automatic position close-out that pulls you out if you've reached a certain loss.
"A trader considering forex needs to understand their objectives, the level of risk they are prepared to take, the amount of money they can afford to trade with, and the amount of time that they have available to dedicate to their trading," says Jane Foley, a research director at trading platform Forex.com. She says forex trading has become popular in the past 12 months with private investors keen to find new asset classes that take advantage of the economic crisis. "The global financial crisis heightened awareness of risk. As a result, investors tended to characterise assets as either 'risky' or 'safe haven'. The US dollar and the yen became core 'safe-haven' trades while high-yielding currencies and sterling were treated as 'risky' trades."
In the past few years, the forex market has grown to become the most-traded financial market in the world, but the bulk of trading is from professional traders, institutions and banks who know exactly what they are doing.
"Successful forex trading involves patience and the willingness to get to know the market by trading forex over time," says Michele Lewis. "It is well suited to people who are looking to take a more self-directed approach to managing their investments."
Forex markets move quickly, and many traders work over short time periods, holding positions for days or even hours. It is a 24-hour market between Sunday evening, when New Zealand opens, and Friday evening when the US closes. This around-the-clock trading and high volume make forex a fast-moving and highly liquid market.
Traders familiar with equities or other investments can be successful in foreign exchange, but it is not recommended as a place to start your online trading career. The speed and fluctuations of the market are more akin to financial spread betting. With spread betting, which also allows you to bet on currency movements, you trade in terms of "pounds per point", where every move in the currency you're following transcribes into a win or loss. "The risk is always that the market can move against you, and in forex these moves can be big," warns David Jones, the chief market strategist with spread betting company IG Index.