Should you Invest in Currencies? Part 1

There’s nothing like old fashioned honest-to-goodness cash. Being loyal readers of my blog, I’m sure you have an idea of how investing in the stock market works. Less familiar to many investors is the global currency market. The currency market is a market for the most basic of all valuable items: cash. In the stock market you buy and sell shares of businesses. In the currency market you buy and sell cash directly, in particular cash from different countries.

The main component of the global currency market is the foreign exchange, also known as forex or FX. I like the abbreviation FX since it sounds vaguely hip, but forex seems to be standard. In the stock market, you don’t actually go around handing people stamped certificates with the names of companies on them (although you used to, and for a fee you can still get the certificates). Similarly, in the forex market you don’t actually handle coins and bills (although for a fee you can). The individual investor in the forex market gets started by setting up an account at a forex broker, just like you get started with stock by getting an account at a stockbroker.

The most basic trades you make with your forex account are buying and selling currencies. Because the exchange rate between currencies is changing, if I use my dollars to buy yen, then the next day use the yen to buy back dollars, I could make a profit or loss. This type of trade is useful because the fees for converting between currencies on the forex market are much lower than at the local bank. I might care about the value of my money in one currency but not want to pay the fees necessary to physically convert it back and forth.

When you think about it, each transaction is really two transactions in one. When I start with dollars and buy yen, I’m really selling dollars and buying yen. The next day when I convert back to dollars, I’m selling yen and buying dollars. In the stock market you don’t normally think about selling dollars and buying the stock, you just think you’re buying the stock. In the currency makets the currency IS the thing you’re trading; every transaction involves changing one currency to another by selling one and buying the other.

to be continued...