Currency trading in simple terms means trading of currencies. The currency trading market is the largest financial market in the world with the daily volume of trade being more than $2 trillion. This is far more than the approximate $50 billion worth of transactions that take place at the New York Stock Exchange. Currency trading is, in other words referred to as forex or FX, which is the short for foreign exchange.
Each country in the world has a currency and these currencies have their own value in relation to one another. These values are not fixed or permanent but keep fluctuating due to several reasons. The first of these reasons is the presence of the real market. We live in an open market scenario where countries have trade with other countries. In this regard, the corporate firms and business establishments doing overseas business need to send and receive payments to and from other countries. The demand and supply of these currencies then lead to changes in their value. The other reason for the fluctuation of the value of the currency is speculation. In the recent years, the second reason has become the prime reason for the currency value fluctuation as more traders are getting into the currency-trading arena with a view to make profits from the change in the currency value.
Currency trading, until a few years back was limited to large financial conglomerates and banks. These were considered the movers of the forex market. However, with the recent advancement in technology and the inclusion of newer types of financial instruments for trading has made the forex market available to the retailers as well. Individual investors, too, can now benefit from the enormous returns available at the forex market and that too at a lower risk and with no extra market knowledge.
Until a few years back, the best option to invest was the stock market. However, with the stock markets around the world taking a beating due to different reasons, people have migrated to other financial instruments, forex being one of them. Currency trading provides several benefits over traditional stock trading. Some of these benefits are:
- The low spreads available in currency trading is a good reason for a trader to enter the market, as the costs to him are low.
- There are very good chances of earning high profits as there is high volatility in the currency market. Therefore, a trader can generate high returns with a small price change.
- Leverage: probably the most appealing factor, leverage is the facility of using different financial instruments like margin accounts to enhance an investment’s probable returns. The leverage ratio for stocks can be as high as 100:1, whereas for the forex market, a leverage ratio of 400:1 is common.
- Lesser choice is beneficial: considering the listed stocks, an investor has to choose from a large number of stocks. In comparison, when forex trading with the major currencies, the choice is limited to just five to six. Therefore, with lesser choice, a trader is able to maintain his focus and prepare his trading plans. He can concentrate on a particular currency pair and accordingly conduct research and make his advances.
- Earning both ways: there are no restrictions to short selling in the forex market. This means that an investor can earn both ways. He can go short or long. This means that there is profit potential either way, though a trader must remember that the risk factor is also there.
- No intermediaries: stock trading has to be carried over through a broker. However, there are no such intermediaries in forex trading. Since there is no central location or market for currency trading, all transactions are routed through the currency selling financial institution. This is beneficial for the investor as there are no additional costs and the deals get finalized directly. Moreover, there are no commissions by these brokers as their charges are included in the bid/ask prices.
- Not be influenced easily: the forex market is enormous and this makes it nearly impossible to get influenced by forces, external or internal. Fluctuations in currency value occur due to economic factors or such factors, which are beyond the control of the market movers. Therefore, the banks, the government and even hedge fund managers are not able to control or manipulate the working of the currency trading market. It is the sheer size of the currency market, which insulates it from being influenced.
- Round the clock trading: the equity markets are driven by the opening and closing bells of their respective stock markets. However, this is not the case with forex trading, as this market is accessible round the clock. Investors can place their trades at any time during the day, as there is the time difference between the various markets such as the European, Asian and the U.S. An investor can thus schedule his trading time and trade conveniently.
With so many benefits in favor of the forex trading, it is not a surprise that traders are supplementing their equity portfolios with forex trading. However, it is an individual’s perception of diversifying his investment portfolio. Some traders have foregone stock trading completely in favor of currency trading while there are some investors that have partial stakes in both.
As a word of caution, I would like to mention that forex trading is not completely risk-free. A trader should take note that, if currency trading has the potential to bring in high returns, it also has the ability to make a trader lose money quickly. The risk factor is inherent and a trader cannot overlook that. He must consider all aspects and do his homework well to succeed with forex trading. The volatility factor, which brings in high returns, can also be a reason for the loss of huge sums of money. Therefore, the best option is to go with a trading plan and use risk management techniques.