What’s Foreign Exchange?

What is forex? This is a hard question. There are such a lot of websites and television adverts that mention forex these days. You know it’s a way that you can make money, but what precisely does it involve?

The word foreign exchange is short for FOReign EXchange. You can see it shortened even farther to FX or 4X. It involves exchanging different currencies in the expectation of making a return when the currency rates change. A straightforward example may help to illustrate this. The currency of most nations in Europe is the EUR, so you would like to exchange USD from your bank for euros so that you would have some money to spend while you are there. You might buy $500 worth of euros two weeks before your trip.

But then, something comes up at the last moment and you can’t go to Europe after all. So you change the money back into USD and put it back in your bank. Now, in the two weeks that you had those EUR, the value of the euro against the dollar will have changed at least a bit. Generally it doesn’t change a lot and thanks to the bank’s commission, you would find you get back less than your original $500. But if the value of the dollar actually fell in that time, or the EUR rose by a lot, you might finish up getting back more than $500. Then you would have made a decent profit from currency exchange.

So when we look at what’s foreign exchange as a way to earn money, that could be a simple illustration. But folks who start currency trading don’t do it by purchasing foreign currency bills from their bank. They are going on the internet and, through a broker, get involved in hopeful trading where you can deal in sums one hundred or even more times bigger than the amount that you have in your broker account.

Clearly, this is a dangerous business, but because you can deal in lots that are 100, 200 or maybe 400 times your own balance, it has the capability to make you a lot of cash.

Posted on December 15, 2010 at 6:21 pm by 51cat · Permalink · Leave a comment
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How to Test Foreign Exchange Systems

First you can use backtesting. Here you take your system and figure out on paper how well it might have done on the recent historical market, i.e. The last half a year or whatever period you choose. This does not take too much time because you can rapidly scroll through historical charts looking for the signals that would have led you to make a trade if you had been operating your system live at that time.

Backtesting should give you an idea of whether a system has potential.

For that reason, it is best to backtest over the longest possible time and perhaps split your tests so that instead of testing, as an example, one entire year when the market might have been especially strong or weak, take the first quarter of year one, quarter two of year two, etc so you test one 3-month period from each year of four years.

The second way to check forex systems is in a demo account. Here you are dealing with the live market but not using real money. Remember that you can test many systems at the same time in a demo account, provided you keep separate records of their performance. Or you can use many demo accounts. In this way you’ve got a better possibility of ending up with at least one profitable system at the end of your period of testing. Forex demo accounts also have got the edge that you are developing your live trading skills and familiarity with a software platform and charting service at the same time as you are running your tests. Most currency exchange brokers will supply free demo accounts which you can use to check currency exchange systems.