Is it possible to travel to Countries like China, USA or Japan with Indian Rupees? Or else if India wants to Import Oil from Russia is it possible to make Remittance in Rupees? The answer to both questions is a NO. Because every country has its own currency and we need to make payments according to that only. This is where foreign exchanges play a major role.
Meaning of Foreign Exchange
Forex is derived by combining two words foreign currency and Exchange. Foreign Exchange is the process of changing one currency in to another currency for reasons such as trade, tourism, commerce etc. Foreign exchange is a global marketplace for exchanging currencies.
We all know that every country has its own currency. In foreign exchange market, currencies are bought and sold. Foreign exchange is traded virtually 24*7. Forex is the world’s largest market. Everyday trillions of transactions are executed and it is most liquid in the world. There are many institutions in Foreign Exchange like the Government, Central Banks and Commercial Banks. It also involves institutional investors, forex grants, individuals and other business.
History of forex market
Forex Market has been around for centuries and people have used barter system, currency system to purchase goods and services. After the Bretton Woods accord began to collapse in 1971, many currencies were allowed to float freely against one another. Banks conduct most of the trading in forex markets on behalf of their clients. There are two methods through which you can earn through foreign exchange
- The interest rate differential between two currencies.
- Profit from changes in the exchange rate.
How foreign currencies are traded?
If you observe all currencies are given code with three letters. For example US dollars are called (USD), Japanese Yen is written as (JPY) , British Pound (GBP), Indian Rupees is (INR). The below mentioned currency pairs account for more than 75% of trade in forex market
Here the currency on the left is the base currency and the currency on the right is the quote currency. The exchange rate determines how much of the quote currency is needed to buy 1 unit of the base currency. As a result the base currency is expressed as 1 unit while the quote currency varies depending upon the currency market fluctuations. When the exchange rate rises, it means the base currency has risen in value relative to the quote currency and conversely if the exchange rate falls that means, the base currency has fallen in value.
Uses of foreign exchange market
- Forex for hedging
Hedging is a strategy that tries to limit risks in financial assets and commodities. It uses financial instrument or market strategy to reduce or offset the risk of any adverse price movements. One can protect currency pair with the help of hedging. There are two methods of hedging foreign currency. First is one can hold both short and long position simultaneously on the same currency pair. This type of hedging is called perfect hedge because it eliminates all the risk.
The second strategy is to create a hedge which would partially protect the existing position from an undesirable move in the currency pair using forex options. This strategy is referred to as an “imperfect hedge”. In order to create an imperfect hedge a trader who has long position in a currency pair can buy put option contract to reduce the downside risk whereas a trader who is in short position can buy a call option contract to reduce the risk stemming in.
- Forex for speculation
Speculation is the activity of guessing without having proper knowledge about the results. In terms of Foreign Exchange it is an act of buying and selling foreign currency under the conditions of uncertainty with a view to earning huge profits.
Often speculators buy the currency when it is weak and sells the currency when it is strong. An investor who is in to speculative trading purchases an asset in an attempt to gain profits from market fluctuations. These are high risk, high gain investments. There is small difference between speculation and simple investment which makes it pretty difficult for the market players to differentiate.
Types of Speculative Trading are
- Margin Trading
- Rigging the Market Rigging
- Cornering A corner
- Wash Sales
- Carry Over
- Blank Transfer
What is forex trading?
It is the process of speculating currency prices to potentially make a profit. Currencies are paired and traded so by exchanging one currency for another a trader is speculating which currency will fall and which currency will rise. The value of a pair of currency is influenced by trade flows, economic, geopolitical events which effects the demand and supply of foreign currency.
How to do forex trading?
Most Forex Traders do not do Forex Trading for the purpose of currency exchange. It operates much like the stock trading. Most of the forex traders buy currencies speculating the prices to increase further.
There are three ways to trade in forex market
- Spot Market: This is the primary forex market where the currency pair are exchanged and rates are determined in the real time based on its supply and demand. Spot markets is where the currencies are bought and sold on their trading prices and the price is determined by the supply and demand and is calculated based on factors such as interest rates, economic performance, perception of the future performance of one currency against another.
- Forward Market: Forex traders here enter in to a contract with another trader and agree to execute the transaction on a future date and also exchange rates are fixed while doing the contract. On the date of the maturity the contract has to get executed as per the contract. This contracts are done privately and not through exchanges. Forward contracts are bought and sold over the counter.
- Futures Market: Traders here have to enter in to contract to buy or sell the currency at a predetermined amount and time on a future date. The difference here is it is done through exchanges and not privately. Futures contract is more standardized contract between two parties. Future contracts are used by many financial players like investors, speculators, companies. Futures are not like stocks. Futures expire but stocks don’t.
Speculators and Arbitrageurs use Forwards and Futures contract anticipating the price fluctuations in future. The exchange rate in these market are based on what is happening currently in the spot market.
What causes fluctuations in the forex market?
Currency market is majorly driven through supply and demand of buyers and sellers. Also there macro economic forces which effects the price. Demand for certain currencies are influenced by interest rates, bank policies, political environment , government decisions etc. Forex markets are always open and currency trading market experiences volatility and fluctuations due to speculators or hedgers where one anticipates prices to go up whereas the other expects the prices to go down.
Let us understand what are the risks involved in forex market
One of the major risk involved in Forex market is fluctuations and forex trading requires leverage. If the trader is enjoying profits the situation goes ok but the scenario changes once the trader makes loss. And transaction costs can eat up the entire amount invested. Secondly traders should not believe any rumor about the currency market because it could land him in trouble. The trader should never forget about the possibility of frauds in the currency market.
Thirdly there is transaction risk involved as there is time difference when the contract is entered and when the contract is executed. The gap in between is crucial as there can be major price fluctuations and changes. The longer the duration between entering and settling the trade the greater will be the risk. Fourth risk is interest rate risk because when a particular country’s interest rate goes high international investors take opportunity to invest in such economy and thus there is a chance that price can go up. Also decline in interest rates can bring down the price which can lead to withdrawal of investments. Fifth Risk can be counterparty risk where the counterparty may default and fail to end the deal. This happens particularly when the market is volatile.
So now that you are familiar with what forex market is all about we will share few tips for trading in forex market for beginngers
Beginnerrs guide to forex trading
- Know the Market
Before Investing in forex market study well. Take enough time to study about each currencies and currency pair. What are the factors effecting the prices of the currency and what returns it has provided in the past such type of questions should be analyzed and only then investment should be done.
- Make a Plan and Stick to It
Before investing have a roadmap about how the trade should be done. It should include risk tolerance capacity, clear vision about profit goals, and after that ensure that the trade is executed exactly the way it is planned.
- Forecast the Weather conditions of market
Fundamental traders prefer to trade based on news and other financial and political data technical traders prefer technical analysis tools and other forecast movements. No matter whatever is the style staying focused and being aware about the market opportunities is very important.
- Know your Limits
This is a simple but useful tip. This includes your risk taking capacity on each trade, and setting your leverage ratio accordingly and never ever take risk beyond your capacity which can end up making losses.
- Keep it Slow and Steady
One key to success in Forex market is being slow and steady and keeping consistency. All traders have lost money in some or the other way. But if you maintain a positive attitude you can always perform better. Educating yourself and creating a trade plan is always good but actual test is sticking to the plan and having patience is real key for earning profits.
How to start forex trading
- Choose a Reputable Forex Broker
Choose a forex broker that will be correct for you according to your needs. Take time for research and then decide only if the below criteria’s are met
- Security and Legitimacy: Your financial information must be safe and secured. Always check whether it is a registered regulatory body to ensure the platform is legitimate.
- Transaction Cost: There is always some amount of transaction cost involved so it is a good idea to hunt for brokerage firms which have best brokerage fees.
- Easy withdrawal and Deposits: A good forex broker should make it easy to access and withdraw your profits.
- Ease of Use: Forex Trading can be complex for the beginners. In such a situation broker who will provide a easy platform should be selected.
- Customer Service: If you encounter any problems then there should be a support structure in place. It is vital to review the customer service options available with the brokers before you start to use it.
- Additional Services: Some Brokerage companies offer certain perks such as low spreads, negative balance protection, VPS hosting for uninterrupted trading. So before choosing brokerage firms one can check and then choose.
2. Start with demo lectures
Many broker platforms will give you to practice with demo trades and money. It removes the risk of losing money actually while but you can learn how the process. While exploring the demo account you have to take a note about how you are reacting while losing money. Practicing discipline is essential to avoid loss and over eager on things can make situation worse. This will actually teach you how to access your risk potential and manage it. This period should be used to learn strategies and techniques and also experiment all types of currency pairs and get more comfortable with different tools and strategies.
3.Use micro accounts
A demo account is just a practice account wherein fake money is used just to learn trading. Once this is done you can start using micro account wherein you can do small transactions and small trade. Once you start putting your own money every loss will actually create an impact on your life. You are going to learn here more about responsible trading than what demo accounts will teach you.
Don’t take too many risk at this point. It is critical to gain a deeper, practical understanding of Forex trading especially if you are a beginner. Before you start to leverage or choose high volatile currency pairs you should remember that only some transactions can pave off. So adequate research has to be done before investing in such currencies.
4.Take time to learn
Before you start your trading it is important to learn about currency pairs. There are vast opportunities available which trader can utilize. For example EUR/USD is considered as the most stable currency pair. As you become comfortable with currency pairs you can start trading with various different type of combinations.
5. Research about different currency pairs
Before you start understanding what is currency and what are currency pairs you should check which currency pair would give best ROI. Also you can take help of various online courses and guides to learn more about currency pairs and then proceed with trading them.
Basic forex terms
Here is a list of basic terms you will often hear within the FX trading industry:
- Currency Pair: Forex trading involves currency pairs where one is bought and other is sold. Together it is called exchange rate.
- Exchange Rate: The Rate at which one country’s currency is exchanged for other.
- Base Currency : The currency that comes first in the currency pair
- Quote Currency: The second currency quoted in the currency pair.
- Long Position(Buy) : Purchase of an asset with the expectation of price rise in future
- Short Position(Sell)- Selling of an asset with the expectation of fall in market value
- Bid Price : the market price for the sale of an asset
- Ask price → the market price for purchasing an asset
- Spread → the difference between the bid and ask prices
- Appreciation → an increase in the value of an exchange rate
- Depreciation/devaluation→ a decrease in the value of an exchange rate
- Gapping: An opening price significantly above or below the previous day’s close with no trading activity in between. This means that a limit or stop order could be filled at a price different from the desired order price.
- Pips: a pip stands for “percentage in point”, and is the smallest price movement any exchange rate can make. It measures the amount of change in the exchange rate for a currency pair in the forex market. A pip is the fourth and final number after the decimal point. Pips are the means by which market profits and losses are quantified
- Lot: forex is traded in lots. A standard lot is equivalent to 100,000 units of the base currency. This is $100,000 if you were trading in US dollars. A mini lot has 10,000 and a micro lot has 1,000 units.
- Leverage: Leverage is a way for an investor to increase their trading power and manage a greater position on the market with a nominal investment. An online broker may offer leveraged trading for up to 30 times the value of a trader’s initial investment.
- Margin: the minimum deposit needed to maintain an open position
- Risk management: involves the use of strategies in order to help control or reduce financial risk. An example is a stop-loss order which is used to potentially minimize losses on a trade.
- Stop loss→ a stop loss order is a risk management tool allowing a position to be closed, once it reaches a specific pre-set price. This can protect against further losses on an open position if prices continue in an unfavorable direction for the investor. Please note that placing a normal stop loss order does not guarantee you will be filled at that particular market price due to slippage.
- Take profit→ a take profit order is a risk management tool allowing a position to be closed automatically, once it reaches a specific pre-set profit goal. This can protect against profits being lost in an unanticipated reversal of price direction before the investor can close the position.
- Profit/Loss→ the proceeds of a trade, which are from realized trade
Forex market is risky at the same time it can earn you lot of money. There is lot of speculation and multiple factors affect the prices. However a smart investor is the one who analyses the market, learns from his mistakes, practice continuously, is vigilant about the market moves and knows his risk capacity.