What is the currency market?
The currency market, also known as the Foreign Exchange market, is essentially a global, decentralized market that serves as a platform to trade currencies. Overall, the global currency market operates on two levels:
- The Interbank Market: This is the section of the currency market that has some of the largest banks in the world as prominent players. In this interbank market, these banks exchange currencies with each other and conduct large-scale trades among themselves. This is an exclusive subsection of the foreign exchange market.
- Over-the-counter Market: This is the section of the currency market where companies and individuals can trade in currencies. With the means of a broker and an online trading platform, anyone can participate in currency trading.
Basics of Trading in the Currency Market
Trading in the currency market always works in pairs and this applies to both buying and selling of the currencies. The value of these trades is determined by the exchange rate, which is the value of a currency with respect to another.
The exact nature of a currency trade is denoted by the appropriate symbols. For instance, INR stands for Indian Rupee, while USD stands for American Dollar. If you were to trade Indian Rupees against American Dollars, the trade would be denoted as such – INR/USD. Similarly, every currency in the world is denoted by three unique letters and the direction of the trade is denoted with a ‘/’ sign.
Functions of the Currency Market
In order to trade prudently with oil, it is important to familiarise oneself with certain features about the crude oil market that makes it unique:
- Transfer: One of the main functions of the currency market is to settle payments by transferring foreign currency from one country to another. It converts one currency into another and facilitates international transactions.
- Credit: The currency market also provides credit in matters of international trade. For instance, an importer can utilise the credit from the currency market to purchase foreign goods and pay off later.
- Hedging: Frequent fluctuations in exchange rates can cause considerable damage to parties and industries depending on these rates to stay constant. Therefore, currency markets provide the facility to such parties to hedge foreign exchange risks. A forward contract is an agreement to buy or sell foreign exchange for another currency at a predetermined price on a fixed date in the future.
Trading in the currency market is typically done in one of three ways: spot market, forward market and futures market. In India, trading in the currency market primarily takes place on the National Stock Exchange (NSE), Bombay Stock Exchange (BSE) and Multi Commodity Exchange Stock Exchange (MCX). The Indian currency trading time extends from 9 am to 5 am. As a potential currency trader, one requires neither cash nor equities to conduct currency trading.
What is currency trading?
Currency trading or forex trading is to buy or sell currency in pairs. For example, today the US dollar stands at 79.37 Indian rupees – if you expect the dollar to appreciate against the rupee, you buy more dollars. Conversely, if you expect the dollar to depreciate against the rupee, you will buy rupees. You must always choose a pair of currencies like INR/USD, for example.
What are the hard currencies in the world?
The concept of hard currencies refers to currencies that can be freely traded around the world and that are backed by strong domestic economies.
For example, currencies like the US Dollar, the Euro, the Pound, and the Japanese Yen are examples of hard currencies as they are widely accepted and also traded.
Does every country issue its own currency?
Yes, every country issues its own currency which is normally issued by the central bank of the country e.g. RBI in case of India, Federal Reserve in case of the US, and Bank of England in case of UK, etc.
The only exception is the Euro region which uses a common currency called the Euro. For example, big nations like Germany, France, Italy, Spain, and the Netherlands have all given up their own currencies and are now using the common currency Euro.
What are currency pairs and how are they traded?
- In a currency pair, there are 2 distinct pieces viz. the base currency and the quotation currency
- The base currency is always expressed as 1 unit
- These currency pairs form the basis for currency trading in India
- However, forex market trading hours on the currency futures exchange are limited while globally the currency market is a 24-hour market
In the rupee/dollar trade, the USD is normally the base currency and the INR is the quotation currency. So when we write USD 1 / INR. = Rs.79, then the USD is the base currency, the INR is the quotation currency and Rs.79 is the value. The base currency is always expressed in 1 unit.
Does the US Dollar have to be the base currency in currency trading?
Not necessarily. Any currency can be the base currency.
For example, in Euro / Dollar trades, it is normally the Euro that is the base currency and the US dollar is the quotation currency. Similarly, when we write INR 1 / Yen = 1.95, then the INR becomes the base currency and the Japanese Yen becomes the quotation currency with a value of Yen 1.95.
How to do forex trading in India (for investors)?
- In India, the NSE and the BSE offer currency futures and also currency options
- Not surprisingly, the USD/INR pair is the most liquid contract but other contracts are also catching up
- Structurally, the currency futures and currency options operate on the same lines as the equity and commodity derivatives markets
- Traders who want to take a view on currency can trade currency futures
For example, if you expect the US dollar to strengthen versus the INR then you can buy USD/INR futures. Conversely, if you expect the INR to appreciate then you can sell USD/INR futures. Also, the margins on currency trading are much lower than equity or commodities trading.
How to do forex trading in India (for companies)?
- Currency futures can be used by companies that have currency risk
- Say you are an importer who has an amount of $5 million payable in dollars after 3 months
- You can hedge this risk by buying USD/INR pair
- You have a payable of $5 million in March 2018
- Your risk is that if the dollar appreciates from 67 to 70 then you end up paying higher in rupee terms. So you can hedge your risk by buying equivalent USD/INR futures
- If the dollar appreciates to Rs.70 then the loss on your import payable will be compensated by your profit on the currency futures position
That is how currency trading in India works.
How to start trading in currencies?
- Step 1: Open a trading account. You can get started with an online currency trading account on the Angel One website absolutely free and begin trading right away.
- Step 2: Do your research. It is important to know what to buy or sell and when to buy or sell. Watch trends keenly. Diligence is the name of the game. If the Indian rupee has been falling against the US dollar, it might be a good time to buy rupees and sell dollars, for instance, depending on future projections.
- Step 3: Start at a modest initial buy or initial investment. Anyone who has traded in forex for a respectable amount of years will tell you that it takes hands-on practice to understand your own emotions and account for slippage i.e. expected rate versus actual rate of execution. Moreover, you can make profits at any amount.
- Step 4: Set a stop loss or limit order with your broker. If your losses cross the set amount, all positions on your forex trading account will be closed immediately i.e. no further trading will occur on that day. You can limit your losses by setting this up free of charge.
How to go about choosing a broker?
Put your money with a broker that boasts a good track record and a ton of experience. Start-ups might make for exciting and empowering work environments but play safe with your hard-earned money. When you open an Angel One currency trading account you benefit from over three decades of experience dating back to 1987.
- Nil charge for opening an account
- Online currency trading account
- 30+ years brokerage track record
- Trial trading account availability
What are the benefits of currency trading?
- Currency trading transaction costs are relatively low and affordable even for beginners in the trading space.
- There are no middlemen. Your profits are yours. You do, however, need to pay taxes on your earnings.
- Forex trading does not involve the risk of loss due to insider trading.
- Currency trading is instantaneous – you don’t have to wait for the execution and settlement of the trade
- The currency market is largely unregulated, private and free, and there is no limit to the amount of currency that can be traded. It does not hold traders to harsh restrictions or require an institution to act as a mediator. It therefore offers opportunities to a variety of investors, ranging from banks, governments, companies to individual traders.
- It also operates on a 24 hours a day, five days a week timeline and provides a large amount of flexibility to traders. It is important to note that in India, the timing for the currency market is between 9 am to 5 am.
- Since one can trade in a wide variety of currency pairs, the currency market also offers a lot of trading options to traders. Traders can choose from trading in the spot market, the forward market or the futures market. In particular, the futures agreements are a popular option since they come in a variety of options (in size and maturity) for traders of all needs.
- Moreover, trading in the currency market can also prove to be cost-effective for several traders. This is because in comparison with other financial markets, the currency market charges relatively low transaction costs for trading.
Is it safe? How can I curtail my risk?
Currency trading is subject to market risk but you can minimise your exposure to risk with:
- A trusted broker
- A set stop loss
- Diligence in conducting research
- Honest risk management (which means avoiding letting your emotions run the show)
Key takeaways from Currency Basics…
- You can hedge your currency risk or even trade using currency futures
- It is beneficial for both individual investors & companies.
- Currency futures are still in a nascent stage in India
- Currencies are typically traded in pairs in the currency futures market