Forex Trading: The Race Of Dollars, Pounds, Yen, Rupee
Forex Trading: The Race Of Dollars, Pounds, Yen, Rupee
Mar 23, 2018 | 06:09 PM IST
Mar 23, 2018 | 06:09 PM IST
Trading is the toughest place to make easy money. This holds true for all forms of trading i.e equity cash/futures, commodities and forex. In our previous articles, we explored the pros and cons of the commodity trading and F&O trading. The last segment, that we haven't touched upon, of the regulated trading, is forex. Forex trading, also known as currency trading, is the most liquid market and attracts highest volumes from the traders across the globe.
As it is about trading, it's about big profits and even bigger losses, high-flying tempers and street smart players.
Let's take a trip down the lane of the forex trading and try to understand the rules of the game, how to make a winning bid and most importantly--whether you should try it or stay clear of it.
What Is Forex Market?
The foreign exchange market is the forum where all the currencies are traded. Currencies are important in the global markets.and for the people around the world as currencies have to be exchanged in order to carry out foreign trades and businesses.
Let's illustrate this point with an example. Suppose you are living in India and want to buy cheese from Switzerland. As you are buying the product from Switzerland, one of the parties, either you or the firm you buy the cheese from, needs to make the payment in Swiss franc (Currency of Switzerland). This simply means that the Indian importer has to exchange the equivalent value of Rupees (INR) into Swiss franc.
The same goes for travelling. An Indian tourist in South Africa will not be able to make payments in Rupees when he/she goes on a jungle safari as it is not a locally accepted currency. To get ease in the local transaction the tourist will have to exchange the rupees for the local currency, in the case of South Africa, the current would be Rand. The need to exchange currencies is the driving force of the forex market. As there are many different currencies changing hands worldwide, it creates the demand-supply dynamics in the forex market which eventually accelerates the forex trading.
Transactions like these which happen across the world at a huge volume creates a demand and supply for certain currencies. As a result, the value of these currencies goes through price fluctuation.
Owing to these reasons, the forex market is the biggest and the most liquid financial market in the world. Its market size makes other markets look like a dwarf. Even the equity market and the commodity market which enjoy a high traded volume everyday look smaller in comparison with the forex market. Unlike stock market or commodity market, the forex market, being an international market, doesn't have a central marketplace or an exchange like Nifty, Sensex and MCX. In forex, trading is conducted electronically over-the-counter (OTC), which simply means that all transactions are carried out through a network that connects all the traders across the world on a digital platform which totally nullifies the need of a local, centralised exchange. The forex market is open 24 hours a day for the five and a half days of a week. Currencies are traded worldwide in the main financial markets of London, Hong Kong, Tokyo, Zurich, New York, Paris, Frankfurt, Singapore and Sydney - across all the time zones. What it means is at the time the trading day in the U.S. ends, the forex market begins again in Tokyo and Hong Kong. The currency market is capable of being highly active any time of the day, with price quotes shifting on the constant basis.
How To Trade In Forex?
Forex trading is somewhat similar to trading in equity. Of course, in equity, you trade either the stock or the underlying stock (future & options) and in the currency market, you have to trade the pair of currencies i.e. USD/INR, EUR/INR, GBP/INR and JPY/INR, etc. Indian Rupee (INR) would be the common entity in all the trade as you are trading Indian currency against the rise and fall of the foreign currency.
For example, if the US Dollar (USD) is trading at Rs.65 and you think that there is a possibility of USD going up to 65.50, you can buy 1 lot USD/INR at 65. If the USD reaches 65.50 you will make the profit of Rs.500 (0.50*1000). The lot size of USD/INR future is 1000. Similarly, if you feel the USD price will come down you can take a short position (sell first, buy later) and make profits from the falling market.
How To Open A Forex Account?
In India, most of the brokerage firms which provide demat account for equity and commodity also provide forex trading services. There are some full-service brokers firms like ShareKhan, SMC Global, Edelweiss while discount brokerage firms like Zerodha also provides the platform for forex trading. The brokerage of these firms varies but the standard charges like trading and security taxes and GST are levied on all the transactions. For forex trading in India, it is mandatory for a trader to be KYC compliant.
Essentially, there are two ways that retail and institutional traders can trade forex - in the spot market and in the futures market. Amongst these two types trading in the spot market is considered to be the most popular and it is the largest market because as it is the real "underlying" asset on which the futures markets are based on. Earlier the futures market was the most popular amongst the traders as it was open to individual investors for a longer period of time. However, with the changing time, the dynamics of the trading market also changed. The advent of electronic trading and various forex brokers brought spot market back into the limelight.
It has seen a large surge in activity and has surpassed the futures market as the favoured trading market for retail investors. Such is the popularity of the spot market that whenever people talk about the forex market, mostly they are referring to the spot market. The futures market is more patronised by the big companies that need to hedge their foreign exchange risks for a specific date in the future.
What Is The Spot Market?
The spot market is the market where currencies are bought and sold at the current price. The price of currencies is decided by the supply-demand dynamics. However, there are various other factors which have an impact on the price movement of the currencies in forex trading. Issues like current interest rates, economic performance, investors view of ongoing political conditions (both locally and globally). In the same line, things like how one currency would perform against another currency in future also have a huge impact on the price movement.
When a deal is settled in a spot market it is called a "spot deal".
In the forex trading, the buying and sellings is a bilateral deal in which one party gives a mutually agreed upon amount to the counterparty and gets a stipulated amount of exchanged currency at the exchange rate value. All the settlements in the spot market are done in cash. Like equity, all the trades that happen in the spot market take two days for settlement.
What Is The Futures Market?
Unlike the spot market, the futures market does not trade in actual currencies. In the futures market, trades are carried out on contracts that represent claims to a certain currency type. Here the actual currency is just an underlying asset. The value of a future contract mimics the value of the underlying asset.
Should You Trade Currencies?
Now that we have learned about how the forex market works, you must be wondering whether you can try your hand at it or not. It goes without saying that like all other forms of investment, there is strong risk factor involved in forex investment and trading. However, there were questions about the legality of the forex trading in India. The answer to that is that it is entirely legal as the trading is conducted on the accredited exchanges like BSE & NSE and all the transactions are monitored by SEBI. Thus there should be no confusion about the legal standing of the forex trade.
As far as whether you should do it not is concerned, here are some of the points which will help you make up your mind.
Exercise Utmost Caution In Volatile Markets
The driving force of the market is its volatility. However, understand that it's a two-way sword. It can bring your profits but if you are not careful in your trading it can also ruin your trading capital. When the market is volatile, it moves sideways, as a result, the spreads grow and your orders slip.
Always ensure that you factor in volatility in your trading strategy. If you are a beginner, you have to come to terms with the fact that once you enter a trade, anything can possibly happen, and it can totally neutralise your strategy. As you mature with the experience, you will realise that most of the times your trades go wrong.
The famous example is the crisis with the Swiss franc in January 2015. It finished businesses of many professional traders and brokers in a matter of few hours.
The Trading Thumb Rule - The Trend Is Your Friend
In trading, It doesn't matter whether you are a new or a professional trader, your best chance to get a winning trade depends on your ability to identify the trends and trend reversals. In simple words, you have to understand the momentum of the stock, commodity or the currency you are trading on.
To illustrate this point better here is an example, you might think that the US dollar is currently overvalued and there is a possibility that it will correct as it has been overvalued for a long time. Here your thinking is directing you to take a short position. However, if the trend suggests that the price is moving up, an expert trader will disregard his/her thinking and follow the trend.
Technical Analysis: Traders' Favourite Tool For Analysis
Forex traders rely heavily on the charts for analysis. All the currencies and their price movements can be tracked on charts. There are various types of charts i.e. line charts, candlestick charts, etc. Similarly, there are various indicators and oscillators which help to identify the trends and reversals which are important to ascertain entry and exit points.
Niveza Editorial Desk :
We are a team of stock market nerds trying to stay ahead of the herd. We spend our grey cells everyday to pave a smooth road for our clients in the shaky world of stock market. While...
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