what is Currency Trading?
The advent of international trade came with several advantages, key among them is the foreign currency trading. Around the turn of the century, retail trading by individuals became more available, and as a result, the popularity of currency trading exploded.
Whether you are an investment professional or just an individual trader, the forex market, also referred to as the currency market, is where money flows. It amounts to about $5 trillion per day, thus making it the world’s largest investment market. In comparison, the bond market is about $700 billion while the stock trading is only $200 billion a day. Therefore, it would be safe to say an hour’s worth of trading in the currency market equals the total trade volume in the stock market.
However, currency trading for starters can be tough. This is because of unrealistic expectations and lack of trading strategies. What most people may not know is that forex trading is not a get-rich-quick scheme. To help everyone who has got an interest in forex trading, we have put together a step-by-step guide that will explain how currency trading works, key terminologies, and finding a winning strategy.
So what is currency trading and how does it work?
The currency exchange market is the marketplace where different currencies are traded. The transactions could be as simple as transferring your local currency to another one for an upcoming vacation.
In forex trading, when you buy a certain currency, you don’t have to wait until the value of that currency rise to sell it, and then exchange it back to the desired currency. The mobile and online environments have made it easy to make predictions regarding how two currencies, when paired, will perform.
Basically, currencies are traded as pairs. The value of one currency against the other is measured by the movement of currency pairs. For example, the value of the Euro in references to the US dollar is measured by the EURUSD currency pair. When the value of the currency pair decreases, it means that the value of the Euro has decreased while that of the US dollar has risen and vice versa.
The forex market normally operates from Monday to Friday evening. While we have made to believe that it is a 24-hour market, but it can mislead because there are three sessions within that 24 hours. The sessions include the United States, European, and Asian trading sessions. There could be overlap in these sessions, but the main training in each market is normally done during the market hours.
Knowing how the industry operates is also important because the collective effort of all the players create the forex market you trade in. The relative importance of each trading party to the market is usually measured by how the amount of money that the party manages. The participants range from investment banks to small-scale private investors.
Who is trading currencies?
• Banks: The largest category of forex players in terms of the dollar value of the accounts they manage is commercial and investment banks. Generally, banks trade currencies on behalf of their clients who may be involved in international trade operations. They are also market makers on their own right because they trade in their own accounts.
• Governments: Because most governments control their central banks, they are a major player in the currency trading market. To manage its currency and improve the country’s inflation, central banks often trade their own currency.
• Companies: Big companies with international operations are also directly involved in currency trading. Some of these companies can use the currency exchange market to hedge their business operations in a foreign nation.
• Traders: Individual forex traders or investors range from small investors to professional fund managers. They usually enter the market with varying level or resources, skills and knowledge. They are speculators who seeking investment profits in the forex market. Also read why forex traders lose so often
Summary of The Main Forex Trading Terms
Pip: This is the smallest unit with regards to the currency pair’s price. It is 0.0001 of the forex quotes. For instance, when the quoted price for the EURUSD pair rises from 1.6667 to 1.6677 that is treated as a pip change of 1.
Spread: The difference between the Ask price and the currency pair’s Bid price is the spread. The spread is usually low for most popular currency pairs. In some cases, the spread could even be less than a pip. On the other hand, the pairs that are traded less frequently usually have a much higher spread.
Margin: The money in the trader’s account is the margin. Since most etail Forex Traders’ may not have the margin needed to trade high volumes that will guarantee them a profit, Forex and CFD brokers usually offer their customers access to leverage.
Leverage: The capital offered by a forex broker to boost their clients’ trading volume is the leverage. So, if you use a 1:10 rate of leverage with the $2,000 you have in your trading account, you are allowed to trade a currency pair worth $20,000. If you start a trade and it is successful, leverage will boost your profits by a factor of 10. Know that if the trade results in a loss, leverage will multiply the loss by the same factor.
As mentioned earlier, forex trading is done in pairs. Also, all currencies are sold to the fourth decimal point. As you start out, trade forex in micro lots because one pip in a micro lot is equal to a 10-cent change in price. This way, it is easy to manage losses when trading doesn’t go as expected. For mini and standard lots, one pip represents $1 and $10, respectively. So if you take into account that some currencies can move over 100 pips in a single trade, you may not want to trade currency in standard lots if you are a beginner because if the trade is unsuccessful, the loss is huge.
Generally, there are fewer currency pairs that are considered major. Currency pairs are usually categorized as exotic, major and minors.
Major currency pairs:
• US Dollar(USD)
• Australian Dollar(AUD)
• NewZealand Dollar(NZD)
• Canadian Dollar(CAD)
• British Pound(GBP)
• Swiss Franc(CHF)
• Japanese Yen(JPY)
Therefore, a major currency pair comprises any of the above paired against the US dollar. Still referring to the above currencies, forex minors comprise pairs that are not paired with USD, for instance, EURCHF. Exotic currencies, on the other hand, are other currencies that have not been mentioned above such as the Norwegian Krone (NOK), the Hong Kong Dollar (HKD), and the South African Rand (ZAR).
The majority of the trading volume is controlled by only 18 currency pairs. Unlike the equity markets where you have thousands of stocks to monitor, forex trading is easier to choose because you are managing fewer products. But this does not mean forex trading is easy.
What Moves Currencies :
Most of the forces that move the stock market are the same factors that move the currency market, the major one being supply and demand. When there is a high demand for the US dollar, the price shoot, and vice versa. Other factors that come into play are new economic data from rich countries, interest rates, and geopolitical stability.
When you start trading forex, you will see the sk’ and id’ prices are quoted. The Ask price is the figure at which you can sell the currency while the bid price is the amount at which you can buy it. Traders make a profit or losses based on the difference.
Forex Trading Strategies :
There are two main strategies to succeed in forex trading: fundamental analysis and technical analysis.
Fundamental Analysis: This is an analysis guided by the economic situation within specific countries or globally. This strategy is more suited for long-term trading, for instance, if you want to buy or sell a currency pair and hold it for an extended period.
Various country-specific economics reports are usually released through most trading days. These could be reports related to GDP, the producer price index, the consumer price index, and policy decisions of central banks. Interested parties can scrutinize these reports to look for positive or negative indications about specific countries that form the currency pair. If, for instance, there are several negative reports on the UK economy, then it is most likely to decrease the value of GBP against other major currencies such as USD and EUR.
Technical Analysis: This is an analysis based on past market behaviors (volatility and volume) and price movements, so technical indicators could include market strength, moving averages, and relative strength indicators. A majority of traders, specifically intra-day traders and speculators, prefer technical analysis when choosing their trading options. Technical analysis can also be used by long term traders.
Forex Market: Where Opportunity Is:
As we learned above, the currency market is one of the most lucrative markets for any trader. The possibility of starting a trading account with just $100 and turn in it into hundreds of thousands or even millions of dollars within a short span of time has become an irresistible draw. However, the lure for easy to get money from this market can also be deceptive because a majority of new investor still lose money, and only a few savvy traders with solid strategies consistently win in the forex trading.
The key to success in this market is patience, robust trading strategy, discipline and risk management. A majority of new traders fail because they gamble all their trading capital, so by the time a million-dollar opportunity knocks, they have already spent all their money.
All in all, currency trading is still an important investment that offers investors a great opportunity for wealth creation. Hopefully, you are now more educated and strategic about forex trading. Just like anything the trading market, learning to trade is not difficult creating a winning strategy often takes a lot of practice. Fortunately, you can operate a free virtual account until you find your winning strategy. From then, you can trade with real money
Currency trading is perhaps the most dynamic asset class to invest in. Because of the huge daily trading volumes its also very suitable for using algorithmic trading strategies. Before you consider to become a trader, make sure you are aware of all the pitfalls of forex trading. Remember, making profit is rather easy, it’s all about making profits consistently. Please contact us in case you have any questions about currency trading.