Cashing in on foreign exchange

Dubai: Investing in the currency markets, known as the foreign exchange market (or Forex/FX for short), was once a luxury only available to high net worth individuals associated with banks, investment funds and large financial corporations.

However, thanks to the increased connectivity to the internet, FX investment has now become something that almost anyone can do from any location they wish, whether it be from their office, laptop or even from their phone.

Why forex?

The FX markets host all currency transactions from extremely large government financial flows, the sum total of all international trade down to the small-scale conversion of holiday money. All of these transactions create a volatile market which investors can capitalise on.

Every investment for profit comes with inherent risk. It has the possibility of going up or down, and investment into the FX markets is nothing different. However, investment in the forex markets is perhaps more attractive than any other market. To start with, the forex markets run throughout the day and night meaning that they are always available to trade. The huge flows of exchange mean that currency is always available to buy and sell.

Finally, the forex markets take direction from every other financial market and so therefore have links to commodities, stocks, futures, bonds, and indices.

So how does it work?

Just by holding any reserves of two or more currencies is the equivalent of investing in the currency market. For example, if you hold all your money in your UAE dirham savings account, then you are completely invested into this one currency.

However, if you also have savings in a sterling account, then you suddenly become exposed to the fluctuations in the forex markets. Should the pound strengthen and the UAE dirham weaken, it would have been beneficial to have more money invested in your sterling account than your dirham account.

This principle of investment can be replicated into any currency you wish. While the movement between currencies was once only available to traders for large investment banks, there are now hundreds of brokers that use online platforms which allow anyone with a bank account to speculate on the movements within the forex markets.

These brokers allow you to buy and sell currency at a click of a button so that you quickly take advantage of market movements. The majority of brokers make investing easier by using one of two platforms: Spread betting or CFD (contracts for difference). Both platforms allow you to invest in a wide range of currencies and accounts, often opened with investment from as little as Dh300.

Spread betting or CFD

Spread betting and CFDs are used around the world for forex investments. Accounts can be opened for relatively little money.

The main reason why these type of accounts are popular is because while you are speculating on one currency gaining in value over another, you never indeed own the currency in question. They also allow you to use your initial deposit as a margin, and leverage your investment.

The most noticeable difference between investing in Forex spread betting and CFDs is how you earn the money. With spread betting, you bet per point, which is 0.0001. For example, the exchange rate between the euro and the US dollar may be 1.4400 and you may think that the rate will increase (ie the euro will gain in strength against the dollar). You could bet $100 per point that this will happen, so as soon as the euro-dollar exchange rate reached 1.4401, you would have earned $100. If the rate reaches 1.4405, you would have earned $500, but if the rate drops to 1.4395, you would owe them $500.

CFDs are slightly different whereas you could choose to invest $10,000 and hope that it strengthens against the euro. You would only pay a margin (typically one per cent) of this amount which is $100. If the rates were to move in your favour, you could sell your CFDs, and the difference in value would be your profit.

Making money

If you correctly pick the direction of the currency markets then you can quickly earn a large amount of money. If you make the wrong decisions, however, you will find that your investment can quickly disappear. It is possible to lose more than your initial investment and therefore you should think very carefully about any investment that you make.

While most brokers offer free trading platforms, many earn their money on spreads and commissions. When opening an account, make sure to find if there are any hidden charges and commissions. When trading forex, you will also need to be aware of overnight financing charges which occur when you let your position run to the following day. These are based on the interest rates of the currency that you are investing in, plus any extra commission that the broker wishes to add.

Chris Canning is a currency analyst at First Rate FX, a foreign exchange specialist.