The idea that trading money can earn you money seems counterintuitive, but there's a lot of money to be made in currency trading. Lots of people engage in this trade without even realizing it, as a matter of fact. Every time you visit another country and swap your dollars for the local coin, you're involved in currency trading. In investing terms, currency trading is known as foreign exchange, or forex (FX). And, believe it or not, the forex market sees more than $2 trillion dollars worth of trading every day.

The bulk of trading involves the currency of eight major players, those with the most robust and sophisticated financial markets:

• United States (U.S. dollar, also called the Greenback)

• United Kingdom (pound, also called Sterling)

• Japan (yen)

• Europe (euro)

• Canada (Canadian dollar, also known as the Loonie)

• Switzerland (Swiss franc, also called the Swissie)

• Australia (Australian dollar, sometimes called the Aussie)

• New Zealand (New Zealand dollar, nicknamed the Kiwi)

Of course, other currencies trade as well. But those listed are the most liquid and the easiest to trade profitably. The most important thing to remember is that currencies have relative value. For example, trading U.S. dollars for Japanese yen will get you a very different result than trading U.S. dollars for euros. That's because the currency pair you're trading is based on each currency's worth in relation to the other.

Currency Trading Is Different

Many of the investments we've discussed until now trade on formal exchanges. Not so with currency trading. Unlike virtually all stocks, ETFs, and options, currencies don't trade in a regulated forum. There's no central governing body (like the SEC). There's no official body to guarantee or verify trades.

This often seems crazy to novice forex investors, but the system (or, rather, nonsystem) works. Because it's a free market system, the forex market is self-regulating, thanks to competition and cooperation among traders. However, if you're planning on testing the waters of currency trading in the U.S., make sure you use an FX dealer that's registered with the National Futures Association, as those dealers agree to engage in binding arbitration in the case of a dispute (meaning you have recourse if a deal doesn't go down the way it was supposed to).

Another notable forex difference: you can trade currencies 24 hours a day during the week. From 5:00 P.M. on Sunday to 4:00 P.M. on Friday, trading is continuous.

Rates Drive Return

If there's one golden rule in the currencies markets, it's that rates drive return. This concept is simpler than it seems. When you buy and sell currencies, they always trade with an interest rate attached: buyers earn interest, sellers pay interest. That seems like the opposite of what you'd expect, but it's how the system works.

From a procedural point of view, you are first selling one currency, then using the proceeds to buy another (though the transactions happen simultaneously). When you sell a currency, you have to pay interest on it (sort of like a bond issuer pays interest); when you buy a currency, you earn interest along with it.

Each currency has a unique interest rate attached to it, computed in basis points. Your net return is the difference, in basis points, between the currency you're selling and the currency you're buying. So if you were selling a currency with a rate of 400 basis points and buying a currency at 600 basis points, your net return would be 200 basis points (or two percent).