What is Currency Trading?
When you open a currency trade in the Forex market, you pick two currencies, and buy one and sell the other at the same time. For example, if you have a EUR/USD pair quoted at 1.07905, this means that if you sell one euro, you can buy 1.07905 dollars. To close your trade, you then sell the currency you originally purchased, while simultaneously buying the currency you sold in the first transaction. Investors hope to make a profit by timing the opening and closing of trades for times when they have correctly price read trends.
Currency trading, at its heart, involves rating the economy of one country against another. When the economy of a country or region is doing well, prices for its currency go up. When the economy of a country or region is doing poorly, prices for its currency go down. Forex traders keep constant track of different countries and/or regions to get an idea of whether their currency prices are trending up or down. Although there are dozens of currencies that you can potentially trade, the vast majority of forex transactions involve the currencies of one of eight different countries or regions: America, the Eurozone (including France, Germany, and Spain), the U.K., Switzerland, Japan, Australia, New Zealand, and Canada.
How Does Currency Trading Work
The forex market has two tiers of providers who can grant access to currency traders: the Interbank Market, also known as Tier I liquidity providers; and the Forex Dealers, or Tier II liquidity providers. Tier I institutions include national Central Banks that handle the reserve requirements for major countries, and receive the lowest rates on trades due to extremely high volume. These providers process approximately 50% of forex transactions. Tier II institutions serve as the intermediary brokers between the Interbank Market and the retail trader.
A Brief History of Currency Trading
Originally, only Tier I providers were eligible to participate in the currency market, because retail traders could not access the tools needed to buy and sell through the Central Banks, and there was a lack of brokers who were willing to pool orders from multiple traders to take advantage of these opportunities. However, in the late 1990s, internet access became more widespread. Eventually private individuals heard about the profit potential of foreign exchange transactions and demanded a way to compete. This led to the creation of a number of brokerages who developed electronic forex platforms which make it possible to trade online.
Risks of Forex Trading
When considering whether to enter into the forex market, traders should keep in mind that there are a number of hidden costs. There is always a difference between the buy price and the sell price of a currency pair. This difference is called the spread. To make any profit, you need to wait until the price has moved enough to cover the spread. Also, when a Forex trade is held after 5pm Eastern time, you may encounter rollover. This is the interest that the Central Banks associated with the currencies you are trading has said is owed or should be paid for that day. If you do not close your trades in time, or if you do not pay attention to the interest due, you can find rollover costs eating into your profits.
Another risk of Forex trading is volatility. Forex investors react quickly to market news, and even though the online trading systems are extremely fast, sometimes they can’t keep up with prices as they change within microseconds. This means that it may not be possible to close a trade without losing more than your initial investment, even if you are diligent about using a protection feature called a stop-loss, which tries to automatically close trades at a point you select. Most Forex brokers make sure clients are aware that they can lose more than their initial investment.
Why Trade Currencies Using Financial Trading
One way to make forex trading easier is to try currency trading through a financial trading broker. This offers good potential to profit from all types of economic movements. With the wide range of available currency pairs, traders can pick between virtually any two regions and speculate on their comparative growth.