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Currency Trading – Beginners Guide


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Intro To Currency Trading

Currency trading is performed on the Forex market where currencies are traded back and forth on a daily basis. Unlike stocks and bonds, the currency market is unregulated by government. All members of this market trade with each other on credit agreements. Another distinguishing factor between the currency market and other markets is the use of dealers instead of brokers. Dealers take on market risk by acting as a counter party to the investors trade. They make their money from the spread in the bid/ask price instead of commission. One advantage to currency trading is you do not have to pay commission to trade. However, currency trading can be an extremely risky due to the high volatility of the market.

currency trading
Photo Credit: Forex Trading Details

Foreign Exchange Market

The first step to understanding the foreign exchange market is knowing about hard currencies. Hard currencies are considered to be reliable because of the short term stability of its purchasing power. Currently these are the British Pound (GBP), Japanese Yen (JPY), Swiss Franc (CHF), Euro (EUR), US Dollar (USD) and to as lesser extent the Canadian Dollar (CAD) and Australian Dollar (AUD).  The USD, GBP, JPY, CHF, and EUR account for over 90% of the world currency reserves.

What Is Currency Trading

Currency trading is the act of buying and selling world currencies. The currency trading market is a multi-trillion dollar market and is the largest market in the world. Individuals, corporations, and banks trade on the currency market or FOREX (foreign exchange market) every day. There are many reasons for trading currency, such as corporations that operate on a global market and need to trade their foreign currency back to their country of origins currency. Recently, individual investors have become much more involved in currency trading as the internet has made it much easier to execute a transaction. An individual investor may strictly trade currency as part of their portfolio or they may be trading currency to purchase and sell foreign stocks and bonds.

How To Trade Currency

As an individual investor you have a few options for trading currency. Most individual investors have started trading currency on the internet due to its ease of use. Currency trading markets are open every day of the week. If you are new to currency trading you may want to research risk management strategies, in addition to researching and understanding what makes the currencies fluctuate in price. There are several strategies including futures which allow investors to gaurd against collapse and other risks involved with currency trading.

Pips

The market moves in denominations called “pips”.  A pip is the smallest fraction that a currency can move on the Forex market.  For the GBP/USD pair it would be $0.0001.  Currency fluctuates usually less than 1% in a day so it is traded in groups called lots and leveraged.

Lot Size

Currency pairs are traded in groups called lots.  There are 3 main classes of lot size.  A standard lot is a 100k unit.  For trading in dollars this would be $100,000.  A mini lot is $10,000, and the smallest available micro lot would be $1000.  This affects how much each pip will cost or return.  A standard lot is $10/pip when the market moves and a micro lot will only be $0.10/pip.  For this reason it is advisable to trade with the smallest lot size in order to diversify trading currency pairs and limit risk.

Leverage

Because the currency market moves in such small steps and requires large quantities of currency to make a significant profit, it’s important to choose what amount of leveraging you want to perform in order to balance risk and reward.  With Forex trading, the amount of leveraging used is significantly higher than trading equities or futures. A standard leverage 50:1 or 100:1 is often used for trading currency lots. To trade with $100,000 of currency, an investor would only need to deposit $1000 into their margin account.  With such a high leverage, the returns are very fast as are the losses when the market moves substantially.  If the market moves 100 pips in a day, which is not all that uncommon, a standard lot with 100:1 leverage can make or cost the investor $1000.  For this reason it’s also important to set stop losses to protect if the market moves against you.

How To Trade Currency Online

With the development of the internet and online trading platforms trading currency online has never been easier. Individual investors have multiple options to choose from for Forex trading. Any one of these financial service companies offers Forex trading:

Since currency trading is not a regulated market the transaction prices are much lower than stocks, options, bonds, ETF’s and other investments. Financial service companies do not charge a commission for trading currency. The only cost to the investor is the spread.

Foreign Currency Rates

currency trading usd to eurCurrency rates fluctuate very frequently sometimes there are huge swings in the purchasing power of currencies, particularly in countries with unstable governments. The rate of at which a currency is worth against another is dependent on multiple factors. Typically you will either see currency rates posts as a ratio. For example if 1 USD equals .75 EUR then for every dollar you trade in american dollars you will get $0.75 EUR. Using the same rate if you were to trade 1 EUR you would get $1.33 USD.

currency trading eur to usdHere is the calculation:

1 USD / .75 EUR = 1.33 USD

Click here to see the current currency exchange rates.

Trading foreign currency performs in pairs, an investor is always long on one position and short on the other. For example, if you want to trade american currency for European you are long on European currency and short on american currency. The basic premise to trading currency is to purchase a foreign currency at its lowest rate and wait to sell it at its highest. Because of the fluctuation it takes well-timed buys and sells to find success trading currency. As with any investment, there will always be risk.

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