Should You Trade Forex?

I've received questions about whether or not it makes sense to trade forex. As with all things finance and investing, the answer is this: It depends.

In the last two weeks, I've had several people ask me about forex. Currency trading is one of the things that many people find too risky for their tastes. And, while the forex market might not be for you, it doesn't mean that you can't add currencies to your portfolio at all.

What is Forex?

Basically, forex is the foreign exchange, or currency market. It's a speculative market, in which you risk money on whether or not a currency will rise against another. The language is that of more conventional trading, but you usually aren't actually exchanging anything.

If you want to learn how to trade forex, there are a number of web sites out there that can help you. When you trade forex on the spot/OTC market, you usually go through a dealer. There is much less regulation, but there is also the potential for large gains. (You can read?a post I wrote for Wise Bread:?Forex Trading: A Beginner's Guide from CommexFX, to learn a little more.)

You can use up to 400:1 leverage to magnify your gains — and your losses. The smallest change in the direction you specify can mean big wins (or losses) for your portfolio. If you're not careful, though, it's easy to lose a lot of money.

Before you decide to trade forex, you should study the market, and how it works, as well as understand the fundamental factors that influence currency movements. Then, you have to be prepared to use only money that you can afford to lose.

The forex market is the largest, most liquid, and most volatile market in the world. You have to know what you're getting into.

Other Ways to Trade Forex

You don't have to trade on the spot/OTC market, though. There are other ways to trade forex with the help of exchanges. Many futures exchanges, including those owned by the CME Group, allow you to trade forex options contracts and currency futures contracts.

However, many people still don't like the idea of trading options and futures. In those cases, it's possible to find currency ETFs. These are exchange-traded funds that track currency performances. Currency ETFs make it easy to gain exposure to currencies, since they are easy to trade on the regular exchanges. Many discount brokerages offer currency ETFs among their offerings — some of these ETFs are even fee-free to trade.

Before you decide to invest in anything remotely related to forex, though, you should carefully consider the situation. Even though currency ETFs are easy to trade, they still carry risk. Make sure that you understand how the FX market works, and that you understand the possibility that things could go wrong for you very quickly.

It can be an interesting — and possibly profitable — exercise to trade forex, but you should only use money you can afford to lose, and you shouldn't start unless you have a good idea of how the forex market works.