For the savvy investor, Forex trading can offer a smart financial instrument that generates profits for a portfolio.  However, like any other investment, Forex trading has its own set of risks and rewards.  Here is a look at the good, the bad, and the scams 

The basics of Forex

Forex, also known as the foreign currency exchange, is the trading of one country’s money for that of another by large banks, currency speculators central banks and governments. Out of all the exchanges in the world, Forex has the highest volume in both buyers and sellers.  Since it takes place through various financial institutions, you can trade on the Forex market at any time of day.

When you invest in currencies, they are quoted in pairs.  The first number is the base currency, and the second is the quote or counter-currency.  When you invest in the wholesale market, there are five numbers that are used, with the last one being known as a pip or point.

Understanding the advantages of Forex

There are several advantages to Forex trading.  Leverage can easily run up to 100:1, allowing you to gain huge profits with small amounts of money.  However, you must keep in mind that trading with more margin than you can afford can be financially disastrous if a margin call is made on your account.

The market is also very liquid; since it involves major currency pairs, the trades are executed almost instantly.  Regardless if the Forex market rises or falls, you always have an opportunity to profit. 

In addition, since the value of currency follows the interest rates and economy’s strength, it can be somewhat easier to predict trends in the Forex trading market than the fluctuations in the equities markets.

Evaluating Forex risks

At the same time, however, there are several disadvantages to Forex trading.  The same leverage that affords you to make a high profit can also be the catalyst for you losing exponential amounts of money.   If the market takes a downturn in your position, then you can face significant losses on your leveraged amount, which could mean you lose your entire initial investment, as well as be potentially responsible for any additional losses. 

You are also at the mercy of brokers, as individual traders cannot deal directly with the inter-bank market itself.  Unscrupulous brokers can widen spreads and refuse trades as they see fit in the current market condition.  This also means that a broker has control of the spreads, which are often significantly higher than the underlying inter-bank rate. 

While there have been past brokerage scams, the Forex market has become more and more regulated.  The key to investing intelligently in Forex is to choose a reputable brokerage.  The trustworthy brokerages are traditionally backed by the large financial institutions.  In the United States, it is important that the brokerage is registered with the Commodities Futures Trading Commission or the National Futures Association . 

Trading futures can be quite lucrative, but also significantly risky.  It is important that you conduct research on the underlying pairs you wish to trade, and that you select a reputable brokerage.  Depending upon your portfolio diversification, trading Forex can be a strong financial tool in your investing kit.