Saturday, December 6, 2008

How is the Forex like the Stock Market ?

Before I compare the Forex with the US stock market, an important point needs to be made. The Forex serves a critical role in the world economy. As trade among international countries increases because of advances in technology and communication, the Forex is there to play a vital function. The Forex has to exist for a simple reason. Let's say Japan wants to sell some products to the United States. We allow these products into our country and the producers of the product get paid. Here is where the Forex comes into play. How much in Japanese Yen should they receive for their product? That depends on the value of the US Dollar compared to the Japanese Yen. When the dollar is weaker than the Yen, the producers will get the money they need to make up the difference. The producers want to be sure they are paid exactly what they are asking for their product. Wouldn't you? The Forex determines this price comparison. So you see, as long as there is international trade, there will be a Forex.

Since most people have a basic concept of the stock market and how it works, we'll use that knowledge to compare the two. The stock market exists so that a company can sell shares of its company (stock) for money. The company uses this sale to raise money to expand their business. These shares are then exchanged, bought and sold, by investors. In the stock market, the usual practice is to buy shares of stock at one price and at a latter time, sell them for a higher price. The goal of all investors is to buy low and sell high. The Forex is the same... buy low and sell high. This is essentially what all businesses do. They buy something as one price, and then they attempt to sell it at a higher price. When you trade the Forex, investors buy and sell currencies.

The Forex is traded a little different that the stock market. When you trade currencies, buy and sell, you trade them in pairs. Because you have to trade one currency for another, the transactions always involve a "pair" of currencies; Japanese Yen and US Dollar or European Euro and US Dollar. The goal of a Forex trader is to buy the "pair" at one price and then try to sell it later at a higher price.

A stock market investor can not only buy a stock and sell it later at a higher price, she can sell stock and buy is later at a lower price. Just think opposite. You will make a profit if you can sell stock and buy it back at a later time if the stock price goes down. This is called shorting stocks. Most investors don't short stock as there are many rules that limit short selling to the market professionals.

Forex short selling does not impose the limitations that are on stocks. Investors can more easily short currencies and make a profit if the currencies do as expected, do down.

The final trade in stocks is with options. You buy an option on a stock to either go up in price or down. If you bought the option that goes up in price when the stock goes up, you've made money. You can do the same for an option that wants the stock to go down. You can also buy options for the Forex currencies exactly like the stock market. The Forex also has what's called Single Payment Options Trading (SPOT). These are not available for the stock market. They are fairly complicated to understand, so do some research if you're interested.

In summary, stocks can be bought and sold. Currencies on the Forex can be bought and sold. You can buy stocks and profit; you can sell stocks and profit. Same on the Forex. Lastly, you can purchase options on stocks to go either up or down. You can do the same with currencies on the Forex.

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