Forex is an acronym for the foreign exchange market, where currencies are bought and sold. Profits are made when one currency strengthens against the other. Because Forex trading is leveraged in ratios between 10:1 and 100:1, depending upon the broker, even an incremental change in the exchange rate can create a substantial profit for the trader.

Currency pairs have been standardized for trading by the IMF. As a holdover from the Bretton Woods Agreement, which lasted until 1973 and which pegged most currencies against the U.S. dollar (and the dollar to the gold standard of $35 per ounce), trades involving the dollar account for more than 80% of all transactions. The other major currencies include the Euro, pound, yen, Swiss franc, and the Australian and Canadian dollars.

Prices are quoted in “pips,” which is an acronym for Price Interest Points. The price of a currency pair is generally quoted to four decimal places, with one pip being the final number. (The yen is the exception, being taken to two decimal places.) Price fluctuations of hundreds of pips are not uncommon, and the leveraged trading means each pip equals one to ten dollars.

Most brokers do not charge commissions, instead taking their cut from the “spread” between the bid and ask prices of currency pairs. The large number of dealers keeps the spread for most of the major currency pairs quite low, between three and five pips.

Trading currencies by definition means buying one while selling the other, so there’s no prohibition against short-selling in the Forex. It’s possible to make as much profit in a bear as a bull market.

The Forex has many other differences from other markets, including:

• extremely high liquidity, with a buyer or seller available at any time
• real-time trading for six days per week, from Sydney and Auckland’s Monday morning to New York City’s Friday evening
• indifference to corporate shenanigans, as currency values are determined by supply and demand
• the impossibility of cornering or manipulating such a massive market, with approximately US $1.5 trillion traded daily
• no gapping due to the high liquidity and long hours

And because the Forex market is not tied to stocks, commodities, or any other market, it can serve as a good means of diversifying one’s assets beyond such low-yield investments as bonds or real estate.

The Forex has no central exchange building. Business is conducted entirely via telephone or the Internet, with almost 50% of all trades now transacted through electronic means. This over-the-counter nature lowers the cost of trading still further. It has also made the Forex more accessible to the small investor at a retail level without minimizing the potential profits.

Besides commercial, investment, and central banks, major Forex participants include corporations and hedge funds. Daimler Chrysler in the second quarter of 2003 generated more profit from currency trading than from selling cars. In 1986, Caterpillar transformed its US $24 million operating loss into a $76 million profit through currency trading. Among individual traders, George Soros netted an estimated $1 billion profit speculating against the Bank of England, and pushed the pound out of the European Exchange Rate Mechanism.