Investor Bulletin: Foreign Currency Exchange (Forex) Trading

SEC O FFICE of I NVESTOR E DUCATION and A DVOCACY Investor Bulletin: Foreign Currency Exchange (Forex) Trading For Individual Investors Individual investors who are considering participating currency rises relative to another, traders will earn in the foreign currency exchange (or “forex”) market profits if they purchased the appreciating currency, or need to understand fully the market and its unique suffer losses if they sold the appreciating currency. As characteristics. Forex trading can be very risky and is discussed below, there are also other factors that can not appropriate for all investors. reduce a trader’s profits even if that trader “picked” the right currency. It is common in most forex trading strategies to em- ploy leverage. Leverage entails using a

relatively small Currencies are identified by three-letter abbreviations. amount of capital to buy currency worth many times For example, USD is the designation for the U.S. the value of that capital. Leverage magnifies minor dollar, EUR is the designation for the Euro, GBP is fluctuations in currency markets in order to increase the designation for the British pound, and JPY is the potential gains and losses. By using leverage to trade designation for the Japanese yen. forex, you risk losing all of your initial capital and may lose even more money than the amount of your initial Forex transactions are quoted in pairs of currencies capital. You should carefully consider your own finan- (e.g., GBP/USD) because you are purchasing one cur- cial situation, consult a financial adviser knowledge- rency with another currency. Sometimes purchases able in forex trading, and investigate any firms offering and sales are done relative to the U.S. dollar, similar to trade forex for you before making any investment to the way that many stocks and bonds are priced in decisions. U.S. dollars. For example, you might buy Euros using U.S. dollars. In other types of forex transactions, one foreign currency might be purchased using another Background: Foreign Currency foreign currency. An example of this would be to buy Euros using British pounds – that is, trading both Exchange Rates, Quotes, and Pricing the Euro and the pound in a single transaction. For investors whose local currency is the U.S. dollar (i.e., A foreign currency exchange rate is a price that investors who mostly hold assets denominated in U.S. represents how much it costs to buy the currency of dollars), the first example generally represents a single, one country using the currency of another coun- positive bet on the Euro (an expectation that the Euro try. Currency traders buy and sell currencies through will rise in value), whereas the second example repre- forex transactions based on how they expect currency sents a positive bet on the Euro and a negative bet on exchange rates will fluctuate. When the value of one Investor Assistance (800) 732-0330 www.investor.gov 1 the British pound (an expectation that the Euro will Generally speaking, there are three ways to trade for- rise in value relative to the British pound). eign currency exchange rates: There are different quoting conventions for exchange 1. On an exchange that is regulated by the rates depending on the...

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