Retail foreign exchange investors account for about 10 percent of the spot forex market, a substantial slice of the $4 trillion daily volume. The leverage available and liquidity, matched by a market open to trade 24-hours, six days a week, has investors crossing over into the land of the Japanese yen, Aussie dollars and the Brazilian real. With vetted brokers competing for business, investors dipping a toe in the volatile forex waters can earn while they learn.
Choose an Investment Type
1. Work with a reputable broker. If you're new to forex trading, take a test drive on a demo account with a broker before you fund an account. Look for a broker that sends your order over an electronic commerce network (ECN) rather than their own intrabank market. The latter is just a souped up bucket shop that bets against you. Check with the National Futures Association to make sure your broker is registered with them.
2. Investigate foreign currency certificates of deposit as an option, however beware of the enticing interest rates. Those high yields are attached to countries that can have highly volatile interest rates. The investments are pretty straightforward -- buy the CD in the currency of the country and redeem it in U.S. dollars. But note that if the greenback gains value, you can easily wipe out gains.
3. Learn the principals of the carry trade. You purchase a currency pair with a high and low interest yield and carry it. That is, you hold the trade for days or even months, and pocket the difference in rates. For example, assume you buy the pair of the Australian dollar and the Japanese yen. Using hypothetical numbers, the Australian dollar pays 4.5 percent interest and the Japanese yen pays 1 percent. Subtract 1 from 4.5 to get 3.5 percent interest. On a $10,000 position, you can earn an extra $350, because 10,000 x 3.5 percent = 350. The pay outs depend on how the broker computes interest, so check their policy.
4. Qualify to trade forex futures. These currency contracts are traded on the commodities exchanges, so you need a futures account with your broker. These trading instruments work best with experienced investors. Futures contracts in general, but foreign currency contracts in particular, have complicated rules. The National Association of Futures has an excellent primer on trading futures. To hold a futures position requires more capital investment, so make certain the numbers make investment sense.
- Foreign Currency certificates of deposit issued by U.S. banks have Federal Deposit Insurance protection, which lowers risk exposure.
- Investing in forex without knowing what you are doing can set you up for disappointment and frustration. Learning how these markets works has a fairly steep learning curve, so take your time and don't enter a position before you're ready.
Items you will need
- Broker account
- Bank of International Settlements; The $4 trillion Question: What explains FX Growth Since 2007; Michael King and Dagfinn Rime; December 2010
- SmartMoney; Best Brokers for Forex Traders; Sarah Morgan; May 2011
- Bankrate.com; Foreign-Currency CDs: Tempting and Risky; Constance Gustke; June 2011
- Babypips.com: What is Carry Trade?
- Hemera Technologies/AbleStock.com/Getty Images