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Forex 101(2011)

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Gold is hardly a bargain. Blue chips are boring. Tired of the usual suspects and seeking bigger returns, more investors are shifting their focus overseas -- not to international companies or emerging markets, but to foreign currencies.

While many investors are still clinging to safety, a small but growing cohort is seeking out one of the riskiest trades around. With the help of new online trading technologies, the foreign currency markets – called forex – have become a popular playground for individual investors. Average daily volume in retail forex trading grew 25% from 2008 to 2009, to $125 billion -- up more than tenfold from eight years previous. And while retail trades make up only about 3.5% of the $4 trillion forex market, there are plenty of signs that currency trading is becoming more mainstream, including the fact that investors are asking their brokerages for it: In the last six months, customers have started asking for access to the currency markets on their Scottrade platform, a company rep says. Meanwhile, investor advocates are watching this trend with trepidation, noting that the currency markets are far more complex than the stock and bond markets, and that the potential losses are huge.
Not long ago, investors barely had access to the yen or the krona. Forex transactions were the provenance of people or firms who actually needed foreign currency to conduct business. But in the last few years, as the markets have become more technologically advanced – you no longer need to pick up a phone and call a bank to check a price, for example – investors have come to view currency as a way to make money, says Sang Lee, a managing partner at the Aite Group, a financial services consulting firm. If a trader believes the euro will rise against the dollar, he can buy euros and sell dollars today, with the hope that he'll be able to make the same trade in reverse in a few hours or days – and come out ahead.
That can be very lucrative. Movements in the currency markets are small, so traders rely on leverage – making their trades with money borrowed from the brokerage, sometimes at a ratio of as much as 50-to-1 – to inflate the potential returns. If you buy $100,000 worth of euros at $1.3673 each and sell at $1.3683, the net gain is just $100, or 0.1%. But with leverage, an investor can put up less than $3,000 to make that $100,000 trade. Now that $100 represents a 3.3% return – 33 times bigger than if you'd invested the full $100,000, and not bad for a single day's investment. Currency speculation also attracts investors because it's considered to be uncorrelated to equity returns, Lee says: The stock markets can soar, tank, or stagnate, and there's still money to be made – or lost – in the currency markets.
And today, retail investors have access to these markets. Globally, dozens of online brokerages now offer forex trading platforms, most of which launched within the last 10 years. It functions something like options trading, where customers are asked to name the price at which they'd buy and sell a specific currency pair. It's fairly complicated, and just as new to investors as it is to the brokerages. To encourage investors, the sites that offer forex trading platforms tend to provide a lot of education and coaching – background information, demo videos, FAQs, and so on. Brokers like FXCM, GAIN Capital, or Oanda typically offer demo accounts so beginners can practice making trades, as well as a kind of "mini" account that allows a lower minimum balance than a standard account, Lee says


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