Hello friends, and welcome to another podcast by Angel One!
As a trader, you must be already familiar with equity trading and futures trading. But there is another financial market that is bigger than the equity and futures markets combined! It is the Foreign Exchange market, also called Forex.
Today we will be discussing what Forex trading is, and how you can use it to build wealth by trading in currencies. Success in the forex market comes with its own set of risks. We will be discussing the risks of trading in forex.
Now, you must have seen the exchange value of currencies being mentioned in the news. In India, the value of the rupee is continuously monitored against the US Dollar, amongst other currencies like the European Euro or the British Sterling Pound. The exchange value denotes the value of one currency against the other. For example, when the exchange value of Dollar to Rupee is 75, it means that in exchange of 75 rupees you would get 1 Dollar.
Forex trading is essentially the buying and selling of currencies. Forex traders make what is known as a speculative trade. They bank on the change in the exchange value and gain from it.
Let us try and understand this with the example of a trade Riya earned money from. Riya is an experienced investor who wanted to try her hand in forex trading. So she researched and learnt well about the whole process. After which she decided to trade in the Dollar and rupee. At the beginning of the trade, the exchange value of Dollar to rupee was 75 rupees. Riya had a sum of 15000 rupees. She exchanged it for 200 US dollars. She speculated that the value of the dollar against the rupee will increase through the day. So she waited and monitored the market for any changes in value. This strategy of selling an asset with the intent of buying it back again at a lower price is known as a short position.
Her speculation turned fruitful when the value of 1 USD increased from 75 rupees to 75.75 rupees during the day. Now Riya’s 200 dollars were worth 15,150 rupees. That is rupees 150 more than her invested capital. This strategy of purchasing an asset in the hopes that its value will increase in the future, is known as a ‘long position’.
I know what you’re thinking, the returns seem to be too low. And it would take thousands of successful daily trades to be able to build a sizable investment corpus.
This is where it gets interesting. Remember when I said Riya wanted to try her hand out at forex trading? Well, this was her first trade. After this, she used leverage to gain more returns.
Leverage is an investment strategy where the trader uses borrowed capital to increase the potential return of an investment. She contacted her brokerage firm to utilize this leverage. Her brokerage permitted a leverage of 10x on her initial capital. She had rupees 30,000 as an investment amount this time. So she was able to start with a capital of rupees 3 lakhs. At the exchange value of rupees 76 per dollar, she was able to purchase about 3950 dollars. When during the day the value rose to 76.8 rupees, she exchanged the dollars for a little more than 3 lakhs 3 thousand rupees. After this, she returned the borrowed amount, that was rupees 2 lakhs and 80 thousand. On her investment capital of rupees 30,000, she earned over rupees 3000 in one trade. The returns amount to 10% of the capital here.
With greater leverage, the potential of returns can be increased. The possibility of such returns in a short window of time like a trading day makes currencies the most liquid asset anywhere. But there is no reward without risk. A potent deal like returns from forex trading comes with a high risk potential, too. If by the end of the day the price action hasn’t moved according to your speculation, you could be in trouble. If the trade closes unfavourably-- for example if for Riya the dollar’s value had gone down instead of up, there would be losses.
This is especially risky while trading with leverage. High investment capital can conversely lead to high losses. It is important to discipline oneself with a limited leverage to limit potential losses. It is also advised to not trade in currencies in volatile markets. Being up to date with global financial and political events can help you make informed speculations about currency values.
Forex trading does have its risks. But with proper research and healthy leverage you can minimize your risk and build your corpus over time.
To find more about how you can invest your money to build long-term wealth, visit www.angelone.in.
And as usual, happy investing!