Did you know that Currency trading is one of the largest markets in the world? Are you a newbie in trading? Do you want to explore how Currency Trading works? Want to trade in international markets? What makes currency trading or forex trading so unique from other financial vehicles? Let’s speculate!
What is Currency/Forex Trading?
Currency trading allows you to trade internationally. Investors and traders from all over the world buy and sell currencies. Currency trading happens in pairs. Currency Trading is a decentralized market. It means that you can invest and trade with the aid of the technology directly, instead of depending on a centralized exchange.
According to Analyzingalpha, globally the Currency Trading market is worth $2.4 quadrillion. It is the most liquid financial instrument. Currency trading is the largest financial market, when compared to stocks, commodities and fixed income. Not because it consists of 170 different currencies. It is because it enables retail investors to central banks to gauge the profits from currency fluctuations depending on the global economy.
Let’s look at how the global largest financial market actually works!
How Does the Forex Market Work?
According to the data from IG, approximately $6.6 trillion dollars worth of transactions occur daily. In which, individuals, banks and companies are the major participants. When you participate in currency trading, it is similar to buying assets, in terms of currencies.
In the currency market, the currency pair denotes that the value of one currency is relative to the value of the other. It decides how much of Country X’s currency can be bought by Country Y’s currency. In the forex market, the global network of financial centers deals with transactions 24 hours a day. The forex market remains closed only on weekends.
The currency market globally functions on two levels. One is the intrabank market and the other is the Over-the-counter market.
In the Intrabank market, the banks trade on large scales among themselves. Large banks participate largely. They exchange currencies with each other. In Over-the-counter market lets individuals trade in currencies. All you need in the over-the-counter market is a forex broker and an online trading platform.
The Forex market has made currency conversions possible across borders from a decentralized platform. It contributes greatly to the global economy. It has facilitated global trade that involves investments, financial transactions, the exchange of goods and services, etc. Certain terms that you should know as a forex/currency trader are as follows:
Lots in Currency Trading
A ‘lot’ is a unit to measure the transaction amount. If you place an order on a currency trading platform, it is quoted in lots. It determines the number of currency units that you buy and sell in specific amounts.
In currency trading, you place an order in sizes. There are mini (10,000), micro (1000), and nano (100) lot sizes. The standard lot size in currency trading is 100,000 units. You can imagine a carton containing dozens of eggs. That’s what the term lots’ functions as in currency trading.
Spreads in Currency Trading
Spread is the minimum cost built to buy (bid price) and sell (ask price) currency pairs. You will find a price difference in the quoted price. In a currency pair, this difference between the asking price and the bid price is the spread, also known as the ask/bid spread.
Spread defines the rate at which a forex broker sells the currency and buys the currency in the currency/forex trading. The spreads can be narrower or wider. It depends on the currency involved, the economic conditions, and the time of trading initiation (in a day).
Now, the question you may get is How can such spreads be measured? The answer to it is by measuring the ‘Percentage in Points (Pips)
Percentage In Points (PIPs)
Percentage in points (Pips) is a unit of measurement for forex trading. It is the measure of change in value between the two currencies in forex trading. If EUR/CHF is seen moving from 1.0052 to 1.0053 then, the increase in value is 0.0001 CHF. This rise in value becomes 1 PIP.
In a currency pair, the smallest change in value would reflect in the last digit. In USD-dominated currency pairs, the pip is up to 4 decimal places. In the Yen-dominated currency pair, the pip is up to 2 decimal places. For example, USD/JPY is 0.01.
Pipettes
It is one-tenth of the percentage in points (PIP). This means, 10 pipettes make a PIP. These are movements measured in forex trading across the fifth decimal place. It is also called a point or a tick in forex trading.
Pipettes in useful in representing the spreads in forex trading. It is for those forex brokers who offer low spreads. It is useful for traders those who do Scalping or day trading, but not useful for traders who trade in a much longer timeframe.
Leverage
Leverage in currency trading is capital that the trader borrows from a broker. Leverage is a short-term loan. It allows you to take hold of a big position at a minimum capital. It enables you to maximize your profits.
Leverage is denoted in terms of percentage or ‘X’ of your forex deposit. For example: If your forex broker provides you with 70X leverage, it means you can trade in forex up to 7 lakhs.
Leverage depends on the forex margin. It goes even up to 100X.
How does Currency Trading work?
Retail forex brokers, investors, banks, hedge funds, central banks, investment management firms, and corporations are the participants in Currency Trading. When one currency appreciates in value against another in pair, you buy the appreciating currency.
Primarily there are two ways of trading in the currency market. One is the spot market and the other is the cash market. In India, the preferred way of currency trading is through futures. It is done through the NSE, MCX-SX and BSE.
One of the most basic things to know about currency trading is that it works in pairs. It involves taking a position on the currency pair. For example, USDINR, EURINR, GBPINR, and JPYINR are the pairs that BSE or NSE provides for currency trading in India.
Currency Pairs In Forex Trading
To trade in the currency market, we buy and sell currencies in pairs. They are bought and sold in units. The currency that you buy, is the base currency. The first currency in pair represents the base currency. The quote currency is the second currency in pair. The currency that you sell is the quote currency. Pairs allow you to make a comparison between how many units of quote currency you need for buying the base currency.
When you purchase a currency pair, it is the base currency that you receive and sell the quote currency. The ‘ask price’ and ‘bid price’ are the two important terms that one needs to understand in currency trading.
When a forex broker buys a base currency for a trader in exchange for quote currency, it is the ‘bid price’ that a broker pays. The price at which the broker sells the base currency to a trader in exchange for quote currency is the ‘ask price’.
Currency Pairs To Trade As A Beginner
If you are a beginner in currency trading, then you might want to look for the best currency pairs to trade. If you want to trade in and earn some extra dollars, then these below-listed trade pairs are going to be helpful!
It is crucial for a newbie to figure out which pair to trade with. So, here is the list of currency pairs to trade, as a beginner. Although there are several factors that one should take into consideration in currency trading. Let’s look at each pair and the potential trading brownie points they have. You can refer to these to chart out the ones that have potential.
GBP/USD Currency pair
The major and common currency pair is GBP/USD- Great British Pound & US Dollar. It is widely known as Cable. The spreads of GBP/USD are low.
It has the ability to generate large profits even during small market fluctuations. It is one of the best currency pairs to trade as it is less volatile and hence involves less risk.
USD/JPY Currency pair
Beginners should look for low-risk trades, and aim for small profits in the beginning. USD/JPY has low volatility and tight spreads. USD/JPY thus becomes one of the best currency pairs for beginners.
Both countries are mutually influenced by events occurring. Hence, one has to keep track of the current affairs of both countries.
EUR/USD Currency pair
In a Euro there is stability and US Dollar is known to be one of the most frequently traded currencies. Its features like predictability, low volatility, low spreads, and liquidity make it the beginner’s best choice for currency trading.
It relatively moves very less in high price range movements. Hence, as a beginner in currency trading, you have a high chance to turn your fortune around.
AUD/USD Currency pair
To practice currency trading as a beginner, AUD/USD is one of the best choices. It is less volatile but highly liquid. It is not very likely to spike up and go down suddenly.
It is known to be one of the least volatile currency pairs in forex trading
USD/CHF Currency pair
This currency pair is also the best option for those who are looking at low-risk trading options. CHF, the Swiss Franc is a stable and reliable currency in terms of fewer fluctuations.
USD/CHF is a predictable, low-volatility, and low-risk currency pair. Hence, it is also a stable currency pair. So, as a beginner, you can try to trade in USD/CHF currency pair.
How to Trade in currency?
Now that you are already familiar with what terms are important in trading, let’s find out the steps to undertake in currency trading:
Know the Basics
You need to know the basic currency trading terms, the study of pips spreads, and lots. You can then move to more advanced concepts to sharpen your strategies. Like, risk management, technical analysis, and fundamental analysis of how currencies work.
Through online resources like relevant online videos, and webinars and offline materials like books, chart-based books can be of great help.
Choose A Broker
Authenticity plays an important role here. Opting for a genuine broker like Value4Money financial services in Vadodara can help you start currency trading along with personalized financial guidance to meet your financial goals. To connect with the Value4Money team, you can call on 9825107677, or mail at [email protected].
Open Trading Account
After you choose the right broker, you need to open a trading account. Fill out an application form. Provide the required KYC documents. The necessary documents will include ID proof and address proof.
The forex broker will then initiate the verification process and activate your trading account.
Selection Of Currency Pair
Choose the currency pair you want to trade in depending on the funds you have, the capital you can invest, and the gains you want (short or long-term).
For example, if you want to do currency trading in India, you can trade in 7 pairs. They are viz.USD/INR, EUR/INR, JPY/INR, GBP/INR, EUR/USD, USD/JPY, GBP/USD.
Execute the trading
In currency trading, you buy one currency when you sell another simultaneously. After you select the currency pair, you can initiate your trading efforts. For that, you need to place a buy or sell order.
You have the advantage of setting a stop-loss. Stop-loss allows you to limit the loss. It also enables you to take the profit order and lock in the profits.
Forex or Stock Trading?
Forex and stock trading, both are financial instruments, but both are different mass-consumer trading markets that traders worldwide invest in. Both are known, for Hedge Trade and making great returns.
The concept that works in both stock trading and forex trading is to buy low and sell high. But, there’s a catch that rules these markets with complexities. That is, finding the highs and the lows. Technical analysis and fundamental analysis are two ways to do that
Technical Analysis
If you ask forex traders, does history tend to repeat itself? You will find their answer to be a firm ‘YES’! They technically do believe in it. Research on past data on price and volume can help you analyze the trends in both stock and currency markets.
Traders examine such historical data, to analyse the best time to buy and sell the currencies and the stocks. The technical analysis primarily is beneficial to forex traders.
Fundamental analysis
Traders adopt a holistic approach while doing fundamental analysis. They research on financial aspects of the overall business to determine the value of securities.
Traders examine how financially well the company is performing, calculating the net profit, equity ratios, public interest in the company, micro and macroeconomic factors, etc. This analysis is primarily followed by stock brokers.
Forex & Stocks Trade Volume
When we talk about volume, it means the amount that gets traded in a specific time period (usually, in a day).
It is much easier for traders to get the order at desirable price levels on the basis of the volume, in a forex market compared to the stock market. This is because of the global participation. There are always buyers and sellers.
The same is not the case with stock traders. Getting their orders executed at a specified price is a big task. When you consider this factor, forex trading turns out to be the better financial vehicle to drive more profits.
How Day Trading and Swing Trading in the currency market work?
In day trading, the traders focus on whether to buy or sell the currency in a forex market on a short-term basis (day). The factors that traders take into account are based on technical analysis. The currency day trading system has graphical interfaces. It comprises Charts, indicators, and currency signals for the execution of forex trade on online platforms.
Swing Trading is for traders who want to profit from the price swings in the currency market. Patience is the key to swing trading. As a trader, you would need to hold your trades for many days at a time. The minimum is two days to several weeks.
If you want to be that trader who does not have the whole day to dedicate to charts but has enough hours to stay up-to-date with current currency news, swing trading can become an option to consider.
Traders examine the market using both technical and fundamental analysis in swing trading.
Risks involved in Forex Trading
Like every other active trading option, forex trading has its own share of risks and challenges.
Knowing the dangers and adequate knowledge can help traders minimize the risk that comes across.
Risks and hazards are something inevitable in a forex trader’s trading journey. Here are some of the risk factors that forex traders should be aware of, to trade mindfully:
Transaction Risk
It is the risk that is related to the time difference between the initiation of the contract and the settlement. The boon of forex operating round the clock. But, it also can be a bane because exchange rates can change before a trade settles.
The longer the time between entering and settling of trade, the higher becomes the risk. Traders may face excessive transaction costs with alterations in the exchange risk.
Interest Rate Risk
International traders usually look to invest in a country, when the rate of interest of that country goes up.
The notion is to enhance the demand, and hence the price of the currency. Similarly, the interest rate when drops down can also affect the currency.
When the interest rates fall down, investors would seek withdrawal of the investments.
Country Risk
There should be enough reserves in the central banks of developing countries like India. As developing countries depend on leading currencies like USD.
Such countries can face devaluation if there are recurring deficits. In such situations also the investors tend to withdraw, as they predict the losses, hence affecting the forex market.
FAQ about Currency Trading
How to Start Trading Forex?
What are some factors affecting exchange rates in forex trade?
There are risks related to forex trading like transaction risk, country risk, counterparty risk, and interest rate risk that a forex trader has to acquaint oneself with.
