Forex trading is a very commonly practiced form of stock market trading, or stock market investment if you prefer to call it that. So what is forex and what is forex trading? When a person trades forex, he buys a currency while simultaneously selling another. The two currencies are pitted against one another. Imagine a boxing match. You’re betting on Participant A winning. If he wins, you make a profit. If he loses you make a loss.
In forex trading too, traders in a way bet on one participant winning. Except that the participants are currencies, the currency that the person is expecting to win is what is called a “base currency”, and instead of a bet, the person places a trade on the stock market. Let us understand the fundamentals of forex trading by observing a realistic example: Rohan’s base currency is USD. He trades the USD-Euro trading pair. He expects that the price for USD will increase in the coming months and therefore he purchases USD with a plan to sell them at a later date when the USD rate increases.
Forex trading is always conducted via futures. In other words Rohan, in the example that we are discussing, will buy a futures contract to purchase the USD at X rate by X date and will also buy a futures contract to sell his USD at X++ rate by a later date. Remember that the base currency, or the currency mentioned first, is the one that will be bought or sold. Let’s say Rohan buys USD 1000 for Euros 850 or about 85 Euros per dollar. When he sells his USD, he sells it for Rs 90 per USD and reaps a profit of 5000 Euros. Of course, you must recognise that in real life Currency fluctuations may or may not be as drastic as in the example. As a consequence, earnings amounts may be correspondingly smaller - the trader will need to conduct many, many forex futures contracts in order for his earnings to be significant There is no guarantee that forex rates will move in the direction predicted by the trader.
Currencies are traded the world over, but if you are trading currency in India, you will do so on the forex market here. In India, there are four currencies traded across three currency pairs, namely
Euro-USD
Great British Pound-USD
USD-Japanese Yen
One may choose any of the four currencies to be their base currency. So you can trade Euro-USD where Euro is your base currency, or alternatively you could trade USD-Euro where the USD is your base currency.
Now that we’ve covered the various currencies used in forex trading specifically in India, it is time to look at the various lot sizes used in forex trading.
The minimum quantity that a forex trader can trade is 100 units - that is 100 USD or 100 Yen or 100 Pounds; 100 of whatever you have chosen as your base currency. There are four lot sizes:
A nano lot consists of 100 units
A micro lot consists of 1000 units
A mini lot consists of 10,000 units
A standard lot consists of 100,000 units
Forex trading is conducted by individuals like us, but also by stock brokers, by banks and even central banks, by hedge funds and by investment firms. Multi-national corporations or companies that do business aggressively in other countries, might also want to trade in currencies in order to mitigate their currency risk. As you can imagine, the bigger fish use the larger lot sizes for forex trading.
Earlier we touched upon the fact that forex is traded on the forex market. The forex market is in turn, a platform offered to traders by the stock markets in their country. You can trade forex at
The National Stock Exchange, that you probably know of as the NSE
The Bombay Stock Exchange, or BSE
And
The Metropolitan Stock Exchange, known as MCX-SX
Now let’s talk logistics:
You need a forex trading account in order to conduct forex. This account can be opened with a broking platform. Select your broking platform with care – make sure that your broker is reputed, allows for online access (or better still app-based access) to your portfolio, offers competitive brokerage rates and also offers you access to basic stock market education.
You need not have a demat account for trading in forex.
You absolutely need to understand Futures trading in order to trade Forex
Now that you have a good overview of the working of the forex market, you might want to dive right in. But hold on and listen to a few words of caution first: Cover yourself against any potential risk while conducting your forex trading by ensuring that you are trading with capital that is over and above what you need to keep up your daily life and lifestyle as it is at present. Ensure that all fixed expenses are covered before selecting an amount for any stock trading or forex trading because these are dynamic, highly unpredictable markets and while the potential for earnings is high, the risk of loss is also heavy. Moreover, avoid falling for the classic con of the “guaranteed tip” for earning on the forex market. As mentioned the forex market is dynamic, governed by a variety of market forces not just here in India but also market forces in the country whose currency you are trading and indeed market forces the world over. Keep an eye on the news to make informed predictions and buy futures contracts based on thorough research, not whims or anonymous tips. Practice cautiousness and diligence at all times – happy trading!
