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Posted on 06 October 2012.
There is a growing buzz in investment circles about trading currencies to profit from the fluctuations in various major currencies, which has lead many individual investors wondering how to trade currencies. The answer to the question “how to trade currencies” is not as simple as just opening a currency trading account, which is known as a FOREX or FX account in Wall Street lingo (FOREX / FX meaning foreign currency exchange). This is because there are a number of ways to trade currencies from buying currency pairs or initiating a currency pairs carry trade in a FX account to buying binary currency options in a binary options account.
The first step regarding how to trade currencies is to open either a FX account or a binary options account, or both, depending on the type of currency trading you plan on engaging in. With a FX account, you can buy a currency pair or initiate a currency pair carry trade. With a binary options account, you can buy binary options that are based on the price levels of currencies at specific future dates and times.
With a FX account, you cannot buy a single currency, such as the United States Dollar. You have to buy a currency pair, which means the pairing up of two currencies, such as the United States Dollar and the Japanese Yen. You either buy the Dollar and sell the Yen (long the Dollar, short the Yen), or buy the Yen and sell the Dollar (long the Yen, short the Dollar). If you are long the Dollar in a Dollar/Yen currency pair position, you make money if the Dollar increases in value against Yen, and vice versa, if you are long the Yen.
A carry trade is a currency pair trade that involves being long a currency with a high interest rate and being short a currency with a low interest rate. You must pay the interest at the rate the central bank has set for the country in which the currency trades in which you are short, and you receive the interest rate the central bank has set for the country in which the currency trades in which you are long. This interest payout and collection is done at the close of each trading day by the company that manages your FX account, with fees deducted at time of payment. The difference between the interest you pay out and earn, minus the fees, is what you make on a carry trade. Purchases of currency pairs using margin can be made to increase the amount of interest payments collected from a carry trade.
A binary option currency trade is undertaken via a binary option account. A binary option currency trade is a bet that a particular currency will trade at a specific price compared to another currency at a specific future date and time. For example, if you think the United States Dollar will reach a certain level by the time the currency trading market closes, you can buy a binary option that will pay you if that level is reached by market closing. The payout is limited to a specified amount, and can vary considerably amongst the numerous companies that offer binary options.
The preferred way how to trade currencies depends upon a currency trader’s tolerance for risk and their take on how to best trade specific currencies. Whether a currency pair trade, carry trade, or a currency-based binary option, currency trading offers plentiful opportunities to make money.
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