Most people have at least a general idea of what the stock market is. While some people may be very involved investors or traders, even people who don’t participate in it at all still usually know it has something to do with buying and selling stocks, and trying to “buy low, sell high.”
But fewer people know about currency trading, or what the Foreign Exchange (Forex) market is.
The Forex market functions essentially the same as any other market: the main objective is to buy and sell instruments in order to make a profit. The main difference however is that instead of buying shares of ownership in a company as happens on the stock market, currencies are traded against each other. For example, one of the major currency pairs traded in Forex is EUR/USD, which is the Euro vs. the US Dollar. Forex instruments are listed in pairs because a currency only has value relative to another country’s currency. So for example, the US Dollar might be going up against the Euro, but down against the Japanese Yen.
One of the reasons Forex is attractive to beginners is because there are no minimum size requirements, so unlike with stocks or futures, you can actually trade as small as you want. This is helpful to beginners because it allows them to use small position sizes with minimal risk while they are learning. If a futures position goes against you, even if you only had one contract, you may still lose hundreds of dollars which may be a significant loss for you. But with Forex, you can size things accordingly such that even a large move against you may only set you back $10, a reasonable-sized loss which is much easier to deal with.
And going along with Forex’s small allowable position sizes, we also encounter another benefit: low commissions and/or trading costs.
Commissions in Forex work in one of two ways, and it will vary by broker:
Paying an Actual Commission – Some Forex brokers charge commissions in the same sense that stock brokers do; you pay a fee per trade. Most of the brokers that charge commission have their commission set up as a small percentage of your trade size.
“Commission Free” – Some other brokers do not charge a commission, but instead may add a few extra pips to the current price. So if the actual price of a currency pair is currently 1.3977, you may actually pay 1.3978 or 1.3979 in order to buy that currency pair.
In each form of “commission” has its own advantages, so it’s really a matter of finding the kind that works the best with your trading style.
By: Manuel Lightner