Lesson: Buying Confidence: The Forex Market

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Lesson Plan

Conceptually, the Forex market is perhaps the most bizarre of our modern exchanges.

Generally, when trading for profit, you are purchasing something.  When you buy stock, you’re buying ownership in a company.  When you buy bonds, you are purchasing a promise to pay interest.  If you’re on the mercantile exchange, you may very well be buying actual pork bellies, or at least the right to own some down the line. But on the Forex, you buy…money.

In order to really gain insight on how to turn profit trading money for money, you must first understand the reason that currencies become stronger or weaker as compared to each other, and to do that you must understand what, fundamentally, money is.

Money represents a promise, from a government or some other entity, that the thing you are holding is valuable.  Like any other kind of promise, the value you place on that is going to depend heavily on whether you trust that government, and how many other people the government has made that same promise to.  It is, in fact, an illusion of value.  In itself, a dollar bill is simply an interestingly textured piece of paper.  But the U.S. government has placed a mark on it telling us that it is legal tender for all debts, public and private, and we believe it.  As a result, a dollar has value.

Profiting off the Forex, then, is figuring out what that promise is worth, and then comparing it to the promise of (say) Japan in the Yen, Mexico in the Peso, or Brazil in the Real.  This is a whole different ball game than stock trading.  When looking at stocks, you can measure a company’s performance, check out their ideas, and decide for yourself if those ideas will generate profit.

With governments, though, your goal (profit via a strengthening currency) is not necessarily the goal of the government.  It is the stated policy of the Fed and many other central banks that currency lose value over time; inflation tends to drive economic growth.  Indeed, there are rumblings about currency manipulation between countries as they strive to make their exports cheaper and imports more expensive.

Stepping onto the Forex, then, is actually trying to figure out which governments will fail at weakening their currency.  The Real is a prime example.  Invented by the Brazilian government in order to control a rampant inflation problem, Brazil is devaluing their currency as quickly as possible in order to keep their export business.

On the other hand, though, the risk of losing everything is pretty minimal.  After all, you’re buying money.  That money won’t lose all its value unless there’s a coup in the country, and perhaps not even then.  The problem to be avoided is losing a significant portion of your money in wild fluctuations (like the Real).

If you are thinking of trading on the Forex, remember to do your research.  All of the research you put into a corporation when buying a stock is fiddlesticks next to the issues you need to know about a country when investing in its currency.  What are the major exports of a country?  Who is politically in charge right now, and what is their fiscal and monetary policy?  Who are the major economic players in a country, and what sorts of business are they engaged in?  That’s going to require research on multiple companies and multiple people.

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