The internet has made currency trading an attractive investment for investors across the world. The currency market, popularly known as the forex exchange market, is not only the largest market across the world, but it is also the most extensive marketplace as far as the trading volumes are concerned. Today, the forex market trades at a daily volume of over $5 trillion, exceeding the value of all the global stocks combined. The good thing with trading currencies is that the market is highly liquid, avails massive trading opportunities, and the resources required to get started are minimal. This guide explains everything that you should know about currency trading, including how to trade currencies on forex markets.
What is Currency Trading?
The currency market is defined as a decentralized market where global currencies are traded. Currency trading, therefore, is the conversion of currencies, where the involved traders agree on the exchange price. Forex is the avenue used by central banks, companies, businesses, or individuals to convert one currency into another. While some institutions convert currencies for basic and practical purposes, currency trading is significantly used by investors to generate profits. The increase in the amounts of currencies being converted daily triggers a substantial movement in the forex rates, making specified currencies extremely volatile. It is out of the volatility of currencies that the forex market is deemed attractive, as the volatility risk introduces more chances for higher profits.
How Forex Markets Work
Unlike the typical stocks where trading takes place on established exchanges, forex trading is done on Over the Counter (OTC) markets. The forex OTC markets trade on a 24-hour basis through a globally established network of banks and businesses. These banks and companies are spread across the primary currency trading centres, which include New York, London, and Tokyo.
Currency trading is done through a trading platform where investors open a position, speculating whether the value of the market will rise or fall. This means that investors do not usually hold ownership of the traded assets. Instead, currency trading operates on the premise that investors can generate profits by positive speculation on the direction of currencies in the foreseeable future.
Benefits of Currency Trading
Investing in the forex market offers investors a variety of benefits. This list outlines the benefits that come with trading currencies.
The forex market provides high liquidity. Not only does the market trade large volumes of assets at a given time, but there are also large numbers of buyers and sellers who are ready to trade daily. This means that anytime you wish to initiate a trade, there will always be a party on the other end of the trade. On a daily basis, there are banks, businesses, and companies converting currencies valuing over $5 trillion. As a result, there is quick completion of transactions at low costs, making it easy for traders to speculate price movements.
24-Hour Marketplace Access
The currency market is open throughout the day for five days a week. The market only closes between Friday evening and Sunday evening. Investors can, therefore, trade at whatever point of the day. This means that traders can automate trades by scheduling a session when they see fit.
Leverage is another feature that describes the currency market. This feature allows you to trade over what you have in your deposited funds. As a result, you can generate large profits with minimal resources. However, you should be keen when using this feature, as it can equally result in massive losses.
The forex market involves large volumes of trades taking place within every second. This leads to increased volatility in the movement of currency prices. With this level of volatility, investors can earn significant profits by speculating the movement of currency prices in a given direction. However, volatility can be a risk when the speculation goes against the actual market trends. Generally, major currencies such the USD, GBP, EUR and other major economies are less volatile when compared to stocks listed on the S&P500.
A Variety of Currency Pairs
A currency pair refers to currencies from two different countries that are coupled for trade in the currency market. The advantage of trading currencies is that you are given the opportunity to trade a wide range of currency pairs. This means that you can speculate the movement of prices for multiple currencies across major and minor economies, increasing your chances of gaining large profits. Examples of currency pairs include GBP/USD, USD/JPY, EUR/RUB, USD/ZAR, and EUR/CZK.
How to Trade Currencies
The process of trading currencies is not complicated. This guide explains the basic steps of the forex trading process.
Step 1: Identify a Licensed Broker
To invest in the currency market, you will need a trading platform offered by a licensed forex broker. You may have to consider the tools, ease of use, and customer support offered by a broker before registering to a trading platform. Fortunately, the growth of the internet has led to an increase in the number of forex brokers competing for new investment accounts. Investors can, therefore, make more informed decision by scrutinising the various features and benefits offered by platforms.
Step 2: Decide on the Suitable Currency Pair
Different trading platforms provide you with varying options as far as choosing a currency pair. Once you have your brokerage account, you can choose the currency pair that you wish to trade. Ensure that you undertake sufficient analysis of the volatility of a currency pair before deciding on a given pair.
Step 3: Choose the Ideal Type of Forex Trade
There are three major ways of trading currencies, including the following;
Spread Betting – This is a type of speculation where investors place a bet on the price movement of a given currency pair. Through spread betting, an investor speculates whether the price of a currency pair will exceed the ask price or trade below the bid price.
CFD Trading – This form of speculation uses the unit of the base currency to trade a given quantity of forex contracts for difference (CFDs). The base currency, in this case, is the currency on the left, against which rates are quoted. For example, if you trade the EUR/USD pair, then your stake will be in EUR (Euros).
Forex Trading – Currencies are typically traded in sizeable amounts or units referred to as lots, against which this form of speculation is undertaken. These lots are bought in the unit of the base currency. The standard lot size is equivalent to 100000 currency units, while the smallest size represents 100 currency units.
Step 4: Indicate Whether You are Buying or Selling
In currency trading, prices are quoted in terms of one currency against another (currency pair). The currency on the left is known as the base currency, while that on the right is referred to as quote currency. Here is a highlight of what goes into a buying or selling decision when trading currencies;
Buying – You will buy a currency pair if you speculate that the value of the base currency will strengthen against that of the quote currency, or when the value of quote currency will weaken against that of the base currency.
Selling – To sell, on the other hand, your speculation should indicate a weakening in the value of the base currency against that of the quote currency or strengthening in the value of quote currency against the base currency.
Step 5: Add Your Trading Orders
An order is an automated instruction to initiate a trade when the currency prices reach specified predetermined levels. Here are the order options available for your forex trading;
Stop Loss Order – The instruction to initiate a trade at a rate worse than the current market price is referred to as a stop loss order. This order is often used to prevent or minimise unexpected losses.
Limit Order – This is the opposite of the stop loss order, and it is applied to lock price targets. The limit order refers to the instruction to close a position at a rate better than the current market price.
Step 6: Monitor Your Trade
Once you initiate a trade by opening a position, the profit or loss of the trade will fluctuate based on the forex market. With an online trading platform, you can monitor the unrealised loss or profit in real-time.
Step 7: Close Your Trade
Closing a trade in the currency market refers to the sale of your assets, or closing your open position. Once you close a trade, the loss or profit generated by that trade will be reflected in your account in the form of the cash balance.
Forex Trading Sites
The forex trading space is dominated by big brands that offer numerous services to investors. This section indicates some of the best forex trading sites.
IG is one platform that has set the bar high when it comes to currency trading. The company has been in the forex business for over 40 years, offering a wide range of investment products across the globe. IG features charts for technical analysis, premium research tools, streaming news, and integrated trading signals. The platform also allows traders to create numerous workspaces.
This is one of the oldest forex trading brokers, serving traders across multiple countries, including the UK, the US, Canada, Australia, and Singapore. OANDA is one of the few currency trading platforms featuring the zero minimum deposit requirement across the globe. When it comes to transparency of pricing and fee structure, OANDA is a reliable broker.
London Capital Group features a wide range of spread betting and CFDs across multiple securities, including fiat currencies, cryptocurrencies, and stocks. The site has no commissions, and its spreads are competitively low.
XTB is a UK regulated broker, featuring a variety of securities, including forex and cryptocurrencies. Spreads, account fees, and trading costs are considered to rate at the average compared with other players in the industry. However, forex spreads by XTB have, over time, proved to be above the average.
Forex.com is one of the brands that pioneered forex-specific brokerage services. This is the primary brand of the GAIN Capital NYSE: GCAP. Forex.com has acquired various brands, including City Index, which is a leading spread-betting and forex company.
The list of forex brokers is endless. When choosing your ideal broker, consider such factors as brokerage fees, ease of use, tools available, spreads, and security options available.
Risks Associated with Currency Trading
Although trading currencies come with plenty of benefits, investors are also likely to encounter various risks that are linked to the forex market.
Exchange Rate Risk – The risk connected to the changes in the value of a currency is known as exchange rate risk. Due to the steady and volatile movements in the currency prices, the forex market is exposed to changes in the value of specified currencies. This risk can be quite significant if not well managed.
Interest Rate Risk – The interest and profitability of an invested currency are directly proportional to the rate of return of that currency. This means that the higher the rate of return, the higher the interest and profits of a currency. However, with the continuous fluctuation in the currency rates, investors are exposed to losing all interest-bearing rewards.
Settlement Risk – Different continents have varying time zones. As a result, a currency can be traded at a different price in varying time zones within the same trading day. This is referred to as the settlement risk.
Credit Risk – This is the risk of not receiving payment for an outstanding currency position as a result of an involuntary or voluntary action by another trading party. This is often a concern for most banks and corporations trading currencies.
Liquidity Risk – While the liquidity of the forex market is a factor that attracts most investors, any degree of illiquidity can result in massive losses. Periods of illiquidity have been experienced before, especially beyond the European and US hours of trade. Investors are also exposed to this risk when regulations are imposed on currency trading.
Types of Metrics to Use When Trading Currencies
Risk managers, researchers, and individual traders are known for using certain metrics to assess the performance and risk of forex trading. Here are various types of metrics that you can use when trading currencies.
This metric establishes how much a company or trader generates after the payment of expenses. Factors used to determine the net profit include total capital and the period within which the profit was earned.
Percentage Win Rate
This metric establishes the rate of winning trades. It is calculated by dividing all the profitable trades by total trades.
Percentage Loss Rate
This metric gives the loss rate of the losing trades. It is calculated by dividing the losing trades by total trades.
This is the timeframe within which an investor holds a position. It is used to establish whether a trader is a long-term, medium-term, or short-term investor.
Forex markets provide traders a way to exchange virtually any currency across the world and speculate on the value. There are a number of benefits and risks associated with currency trading that were discussed. Interested investors can sign up to any of the trading platforms and deposit a small amount of funds to learn how the markets work prior to committing more time and money.