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Trading in the Retail Off-Exchange Foreign Currency Market: Trading in the RetailOff-Exchange ForeignCurrency Market: What InvestorsNeed to Know National Futures Association 300 South Riverside Plaza, Suite 1800Chicago, Illinois 60606- 6615 800-621-3570 www.nfa.futures.org National Futures Association is a congres- sionally authorized self-regulatory organiza- tion of the United States futures industry. Its mission is to provide innovative regulatory programs and services that protect investors and ensure market integrity. NFA has prepared this booklet as part of its continuing public education efforts to provide information to potential investors. The booklet presents an overview of the retail off-exchange foreign currency market and provides other important information that investors need to know before they invest in the off-exchange foreign currency market. INTRODUCTION Companies and individuals may speculate in foreign currencyexchange rates (commonly referred to as ‘forex’), and a num-ber of firms are presently offering off-exchange foreign cur-rency futures and options contracts to the public. If you are aretail investor considering participating in this market, youneed to fully understand the market and some of its uniquefeatures. NFA has prepared this booklet to educate you aboutoff-exchange foreign currency trading. Like many other investments, off-exchange foreign currencytrading carries a high level of risk and may not be suitable forall investors. In fact, you could lose all of your initial invest-ment and may be liable for additional losses. Therefore, youneed to understand the risks associated with this product soyou may make an informed investment decision. You should also understand the language of the forex marketsbefore trading in those markets. The glossary in the back ofthis booklet defines some of the most commonly used terms. This booklet does not suggest that you should or should notparticipate in the retail off-exchange foreign currency market.You should make that decision after consulting with yourfinancial advisor and considering your own financial situationand objectives. In that regard, you may find this booklet help-ful as one component of the due diligence process thatinvestors are encouraged to undertake before making anyinvestment decisions about the off-exchange foreign currencymarket. Finally, the discussion in this booklet assumes you are fundingyour forex account with US dollars. The principles in thisbooklet apply to all currencies, however. 1 THE FOREIGN CURRENCY MARKETS What are foreign currency exchange rates? Foreign currency exchange rates are what it costs to exchange onecountry’s currency for another country’s currency. For example, ifyou go to England on vacation, you will have to pay for your hotel,meals, admissions fees, souvenirs and other expenses in Britishpounds. Since your money is all in US dollars, you will have to use(sell) some of your dollars to buy British pounds. Assume you go to your bank before you leave and buy $1,000worth of British pounds. If you get 565.83 British pounds(’565.83) for your $1,000, each dollar is worth .56583 Britishpounds. This is the exchange rate for converting dollars to pounds. If ‘565.83 isn’t enough cash for your trip, you will have toexchange more US dollars for pounds while in England. Assumeyou buy another $1,000 worth of British pounds from a bank inEngland and get only ‘557.02 for your $1,000. The exchange ratefor converting dollars to pounds has dropped from .56583 to.55702. This means that US dollars are worth less compared to theBritish pound than they were before you left on vacation. Assume that you have ‘100 left when you return home. You go toyour bank and use the pounds to buy US dollars. If the bank givesyou $179.31, each British pound is worth 1.7931 dollars. This isthe exchange rate for converting pounds to dollars. Theoretically, you can convert the exchange rate for buying a cur-rency to the exchange rate for selling a currency, and vice versa, bydividing 1 by the known rate. For example, if the exchange rate forbuying British pounds with US dollars is .56011, the exchange ratefor buying US dollars with British pounds is 1.78536 (1 ‘ .56011= 1.78536). Similarly, if the exchange rat