There are lots of interesting ways to make money in the financial markets – you can trade stocks, options, commodities, CFDs, ETFs, or cryptocurrencies. However, foreign exchange trading seems to be the most interesting trading activity in the market because you are essentially trading money in order to make money.
The foreign exchange market is the most-liquid market globally as CityIndex notes that the global foreign exchange market records an average turnover of more than $5.3 trillion per day. Foreign exchange trading is more interesting than stock trading because the foreign exchange market is moved by real-life world events. This piece provides insight how you can get started as a foreign exchange trader.
How does foreign exchange trading work?
As geopolitical and socioeconomic events unfold, the value of currencies rises and fall in relation to the value of other currencies. When foreign exchange traders believe that the value of a currency is about to increase, they buy such a currency, and when the price does increase, they sell the currency and keep the difference as profit. Interestingly, the foreign exchange market is a principals-only market; hence, you don’t have to worry about paying commissions on your currency trading activities.
Forex (Foreign exchange) trading is conducted in currency pairs in which you buy one currency (long) and sell another currency (short). For the most part, foreign exchange trading is conducted on the seven most liquid currency pairs – the EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD, and NZD/USD. Some brokers might also offer trades in exotic pairs such the South African Rand or Thai Baht.
The EUR/USD pair is currently trading around 1.2405 – in essence, 1 EUR will buy you 1.2405 USD. If the Euro continues to strengthen against the USD, the currency pair could go up to 1.2463, in which case 1 EUR will buy you 1.2463 USD.
Who trades foreign exchange?
Some of the major participants in the global foreign exchange market include hedge funds, banks, and corporations who must buy/sell the currencies of other countries to settle international trade. High net worth investors who are trying to express their ‘opinions’ on how geopolitical events could affect the economy also trade foreign exchange. Finally, foreign exchange is also traded individual traders who are on the lookout for opportunities to make money off the fluctuations and differences in the relative values of different currencies.
Here’s how retail investors can make money by trading money
You can make money in the foreign exchange market by engaging in the pure art/science of market speculation. The values of currencies are in a state of constant fluctuation as interest rates, geopolitical risks, tourism, trade, and sporting events exert pressure on the forces of demand and supply. Foreign exchange traders on the speculative side of the market can make money by ‘betting’ on how those factors could influence the price of the currencies. Speculative foreign exchange trading provides you an avenue to profit from the increase in the value of exchange rates.
You can also make money (indirectly) from foreign exchange trading by using foreign exchange as a hedging tool. Individuals and corporations with significant exposure to international business will need to hedge currency fluctuation risks. With foreign exchange, you can buy/sell foreign currencies in the forward swap market to lock down the rate at which you’ll conclude your transactions in the future. Traders who participate in foreign exchange as a hedge get to benefit from the interest rate differential between their currency pairs because they tend to hold their positions longer than speculative traders.
A word or two on risks associated with foreign exchange trading
The foreign exchange trading market is a decentralized market where the forces of demand and supply influence prices. At the interbank level, central banks might be able to move the market with the corporation of other banks; hence, individual traders might find themselves at a slight disadvantage in the market. Thankfully, the idea of Electronic Communication Network (ECN) for foreign exchange trading is gaining traction and it might level the playing ground for all market participants.
Another risk that new foreign exchange traders should watch is the pitfall pf placing leveraged trades of trading on a margin. Margin trading allows you to control a larger trading position with only a fraction of the cost in the form of your trading capital. If the trade works out in your favor, you’ll get to book exponential gains as if you have actually invested a large amount of money in the trade. However, if the trade goes against you, the losses can quickly mount up and you’ll need to bring some more money to make up the difference. If you must place leverage trades, you need to be disciplined, cautious, and judicious so that you don’t end up with losses that will require more money than your initial trading capital.
