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Currency Trading Strategies
What is Currency Trading?
Currency trading is the exchange of one national currency for another on the Foreign Exchange market. It represents the largest liquid market in the world with a daily turnover of around US$3.98 trillion according to the Bank of International Settlements.
Currency trading became a viable form of trading and investment after major currencies started floating (changing according to supply and demand rather than fixed to another currency) in 1971. Prior to that, fixed exchange rates mean that you can't profit from buying and selling currency.
However until recently, the typical retail traders were unable to participate in currency trading due to the lack of access to the major foreign exchange marketplaces. This has changed since the availabilty of internet currency trading and dealers who cater for the retail trader.
What affects the Foreign Exchange market?
There is no central control governing the trading of foreign currencies. Currency can be traded anywhere in the world. The main marketplace where a large portion of trading occurs is in London, while other major marketplaces include New York and Tokyo.
Since there is no central marketplace, there is no single fixed exchange rate for a currency pair. The rate can vary depending on where the currency is being traded. Traditionally, the publicised exchange rates are those from the London exchange. The primarily traded currencies involve the major global economies and include the US Dollar, Canadian Dollar, Australian Dollar, Japanese Yen, British Sterling Pound and the Euro.
Other currencies can also be traded, but you will need to watch out for a few things. You have to make sure that the currency is ideally floated and not pegged or fixed to another foreign currency or currency buckets. You will also need to be aware that each currency is also affected by the following:
- the country's GDP growth
- the trend in inflation rates
- the trend in interest rates
- the country's budget surplus/deficit
- the country's trade surplus/deficit
Why trade currency?
The foreign exchange market is a steadily growing market. It is qutie unique compared to other investment and trading tools for the following reasons:
- Trading Volume - as has been mentioned, the foreign exchange market has the largest turnover with US$3.98 trillion changing hands everyday.
- Extreme Liquidity - you are trading one currency for another, hence are always holding liquid assets.
- Geographical Advantage - by trading currency, you are in fact trading on the economic strengths and weaknesses of whichever national market you wish.
- Trading Hours - the foreign exchange market is open 24/7 during the working week, representing the most available trading market in the world.
- Low Profit Margin - Unfortunately, exchanging currencies has a low profit margin due to the bid/ask spread. But large profits can be readily obtained by trading in larger volumes.
- Leverage - Currency can also be traded using derivative contracts, allowing for different investment styles.
What are the Currency Trading options?
The primary method of trading for the typical retail trader would be to trade via the various online trading dealers. Do note that these dealers often do not charge commission on trades, but instead earn their profit via the bid/ask spread by taking the opposite trades to their clients.
The available currency trading tools include:
- Spot Trading - the basic trading of one currency with another.
- Forwards - buying and selling of contracts that enable you to buy or sell currency at a fixed price at a future date, much like stock market derivatives.
- Forex Swaps - the simultaneous purchase and sale of the same amount of one currency for another. Primarily used by institutions to boost foreign currency balances.
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