Foreign Currency Trading: Learning How to Profit from it

In these uncertain economic times, it helps to have an investment opportunity to fall back on, especially if you feel your job may be threatened. If you’ve been networking with like-minded people, you may have heard that there is big money to be made in foreign currency trading. They may also have told you about George Soros, who in 1992 made a profit of over a billion dollars for just two days of work. Obviously, you don’t expect to make that much but even earning a small fraction of that would ensure your family’s financial security. Now that your curiosity has been piqued, you want to learn more.

So, let’s begin with some currency trading basics. What is foreign exchange trading?
Foreign currency trading is an activity akin to investing in the stock market, except that instead of speculating on stocks, you speculate on the price movements of foreign currencies. Forex currency trading is seen as being among the most lucrative of investment opportunities, since average daily trading easily exceeds one trillion dollars.

The buying and selling of currencies is vitally important, since it is the basis for all international trade and investment. For example, an American businessman who wants to export Chinese-made dolls to California can’t pay the manufacturer in dollars because that is not the currency used in China. Hence he has to exchange dollars for Chinese renminbi.

This need to trade currencies to conduct business across national borders is the reason why the foreign exchange market is the world’s biggest and most liquid financial market. The forex market is not a physical place like a stock market bourse, but rather an Internet-based marketplace where online currency trading is conducted through computer networks. Thus, there is also no one central exchange where forex is traded.

There are significant differences, however, between currency and stock trading. Unlike stocks, foreign currencies are always traded in pairs which are called ‘currency pairs’: for example, the US dollar (USD) and the euro (EUR) are a typical currency pair. Trading currencies involve buying units of one currency while simultaneously selling units of the other, and vice versa. Hence, when you buy one dollar in the market, you simultaneously sell a euro. The five most traded currencies are the US dollar, the euro, the Japanese yen (JPY), the pound sterling (GBP) and the Swiss franc.

In foreign exchange or fx currency trading, traders make money by speculating on the changes in the exchange rates of two currencies. For example, you’re trading in the currency pairs of the dollar and euro. Let’s say one euro is currently worth US$0.95; this is called their exchange rate. You decide to buy 100,000 euros for US$95,000. When the exchange rate moves to US$0.98 for one euro, you then sell your euro holdings for US$98,000, resulting in a profit of US$3,000.
Exchange rate information is given through currency quotations. A quote looks something like this: USD/JPY = 201.50. The first currency is called the base currency while the second is the quote or counter-currency. The base currency is always equal to one unit. Hence, the quote above means that one dollar can buy 201.50 Japanese yen.

A quote can be either direct or indirect. If it is direct, then the local currency is the base currency; if indirect then the domestic currency is the counter-currency. In the forex spot market most currencies are traded against the US dollar. If a currency quote is given that does not have the US dollar as one of the currencies, it is called a cross currency. Examples include EUR/JPY and EUR/GBP.

Budding currency traders should also understand the concepts of bid price and ask price. Remember that you are trading in pairs of currencies: the bid price is the buying price and the ask price is the selling price. When you are selling a currency pair you use the bid price and when you buy a pair you use the ask price. In a quote it would look something like this: USD/JPY = 201.5000/06. The bid price would be 201.50 and the ask price would be 201.5006.
This means that if you want to buy this currency pair, you will buy dollars which will cost you 201.5006 Japanese yen per one dollar. If you want to sell this currency pair, or sell dollars to get yen, it means you will get 201.50 yen for every dollar. The difference between the bid and ask price, in this case .06, is called a spread. The 6 difference is expressed in units called pips or points. A pip is the smallest amount the price can move in a currency quote.

Although such movements may seem trivial, they can result in thousands of dollars made or lost since traders commonly trade using borrowed money. This is known as trading on leverage.
Because it is global, currency trading runs twenty-four hours a day, five days a week; when the exchange opens in London, it may already be closing in Hong Kong. London markets account for at least one-third of total currency trading, followed by those in New York and Tokyo. Other big centers of forex trading are in Switzerland, Hong Kong, Singapore, France, Germany and Australia.

The biggest foreign currency trading participants in the market are banks, brokers, customers and central banks. Most currency trading takes place between banks and other financial institutions who make profits through inter-bank trading. Brokers are the middlemen between banks and are also used by currency dealers as a source of information as to where they can find the best deals. Customers such as large corporations go to the market to buy foreign currency for their business transactions. Central banks enter the market to intervene on behalf of their national currencies.

There are five types of forex transactions: spot, forward, futures, swap and options. Spot transactions are the most common type of forex trading and represent the largest market. This is because such transactions actually trade in currencies, unlike forward and futures transactions which trade in contracts. In a spot transaction, the trading partners agree on an exchange rate and make their trade based on that rate, sending the currency once an agreement is reached.
In contrast, participants in forward transactions, as already mentioned, exchange contracts that are claims to a certain amount of currency. The contacts specify the designated price at which the currency will be bought and the date the contract will be redeemed. The reason for the postponement of the actual currency exchange is to avoid financial risks arising from future exchange rate fluctuations.

Futures are a form of forward transaction, but their contracts specify standard sizes and maturity dates as determined on commodities markets. These contracts are traded on a separate exchange from regular forex transactions.

Meanwhile, in a swap transaction, the two participants simply agree to trade currencies for a certain period then reverse the swap at a later date. Finally, an options contract gives the holder the right, but not the obligation, to buy a certain amount of foreign currency at a specified price and a future date.

An investor involved in foreign currency trading usually does not need a big amount of capital to start trading, unlike stock speculators who usually need big amounts to cover their trades. He needs to provide only a fraction of the amount he actually trades in his currency trading account. This amount is called the margin (also known as minimum security) and is intended to cover any trading losses. In the example above, if your broker requires you to have a margin of 1% that means you are need to have just 1,000 euros in your trading account to cover your 100,000 euro trade. The rest of the amount is loaned to you by your broker.

When you trade using a margin, you are said to trading on leverage. Since most daily currency fluctuations are very small, speculators use the availability of large amounts of leverage to increase the value of small price movements. But using leverage can also be extremely risky, since potential losses are magnified: for example, leverage in the forex spot market can reach as high as 250:1. This means that for every one dollar you lose in trading, you owe your broker $249.

Now that you’ve gotten the currency trading for dummies overview, you’re probably raring to begin trading. Not so fast. Foreign currency trading is more complicated than it looks and there are many things that you need to know if you want to invest in foreign currencies (forex) and effectively profit from online trading,

First, a budding trader needs to find a good currency trading broker to conduct his trades. This is essential, since not only will the broker implement your trades, a good one may even take you under his wing and provide you with what you need to succeed in currency trading.
Some things you need to consider when picking your broker:

Is the broker connected with a large bank or financial institution? Is he a registered Futures Commission Merchant or FCM? An FCM can handle futures contract orders and extend credit to their clients who wish to enter into such positions. FCMs are regulated by the Commodity Futures Trading Commission, a US Federal agency which protects investors from fraud, manipulation and unfair trade practices. The CFTC also provides vital financial data about brokers on its website.

What kind of services does your broker offer? Ideally, a broker should offer you a good currency trading platform. This is software that is used to help traders with charting and executing trades. It acts as a channel between the trader and his broker for providing information such as quotes and real-time and historical price data, and also provides an interface to communicate to your broker orders that you want him to implement. This software can be loaded onto the trader’s computer or on the broker’s computer and accessed through the Internet.

Before committing to a broker, ask for free trials to test different platforms. Also, your broker should provide you with other vital services such as research, commentaries and economic calendars.

What leverage options does your broker provide? With a wide range of options you can vary the amount of risk you are willing to take. If your available capital is limited, then you might want a broker who will offer you high leverage.

What are the kinds of accounts the broker offers? Depending on the amount of your capital, you can either have a mini account (where you can trade with a minimum of $250 but with high leverage) all the way up to a premium account (where you need large amounts of capital but can trade with different levels of leverage).

Is your broker honest? There are brokers who are involved in unscrupulous activities such as sniping and hunting (precipitately buying and selling holdings near predetermined points) to increase their profits. If you are trading on a margin account, they may also liquidate your holdings without consulting you when your position falls to a certain level. These practices can cost you money, so avoid these brokers.

Does your broker charge low spreads? Unlike stock brokers, forex brokers don’t charge commissions and they earn their money through the difference in spreads. The lower the spread the broker charges, the more money you can save.

Second, what currency trading strategies are you going to use?

There are two basic types of currency trading systems: technical analysis and fundamental analysis. Of the two, technical analysis is the most commonly used by brokers. But you can use either currency trading system, or both, to make your trading decisions.

Fundamental analysis involves using economic data and political conditions to determine currency exchange rate movements. For example, if an election in India is marred by violence, it can bring down the value of its currency vis-à-vis other currencies. Economic data that can influence the forex market include interest rates, employment figures, balance of trade, budget deficit/surplus, and national income accounts figures (gross national product).

Such economic and political data can be found in an economic calendar which your broker should provide you with. An economic calendar is a summary of important political developments and vital economic data (both current figures and those from a previous period for comparison). There are two types of economic data in the calendar that can impact your trades: high impact and medium impact. High impact data can have an immediate effect on the market so you should be aware of the time such data is released if you are trading the currency pairs of affected countries. Medium impact data may not necessarily have an impact but should be kept in mind.

One example of a strategy that uses fundamental data is a currency carry trade, which uses the differences in interest rates between two countries whose currencies you are trading. In this strategy, a speculator buys the currency that is offering the lower interest rate while selling the currency that has the higher rate. He makes his profit from the difference between the two rates.
On the other hand, technical analysis analyzes past market data to try and predict future price movements, on the assumption that prices fluctuate according to trends and that history repeats itself. Speculators who use technical analysis rely on charts to find the best entry and exit points for their trades.

The most commonly used currency trading charts are: line, candlestick, bar, Heikin-Ashi and Renko.

Candlestick charts are the most popular among currency traders because they are seen as the most accurate. Candlestick charts were developed in the 17th century by a Japanese rice trader after he spent a decade researching the behavior of buyers and sellers. The charts were intended to reflect the psychology of participants in the market. They highlight the fact that when there are more buyers than sellers, the price increases, and vice versa.

When you first see a candlestick chart you would immediately know why it was given this name: the data appears on the chart as a series of bars. The bars communicate the following price information: open, close, high and low. The bars are also given different colors to indicate whether the price is moving upward or downward.

Heikin-Ashi and Renko charts were also developed by the Japanese. A Heikin-Ashi chart looks like a candlestick chart but each ‘candle’ in this chart is computed using information from the previous one. For example, the open price is the average of the open and close prices of the preceding candle; the close is the average of all four price data. Hence, unlike in a candlestick chart, the candles in the Heikin-Ashi are related to each other. On the other hand, in Renko charts, time and volume data are not considered and only price data are considered in charting.
If you are ready to begin trading, here are currency trading tips that might prove useful:
Once you have selected a broker or have a shortlist of brokers you are interested in, you should ask to open a demo account with them. A demo account will allow you to test their currency trading software, as well as perfect your trading skills without risking real money. You should practice trading using the mock account until you can regularly show a profit. A demo account is the ideal way for beginner foreign currency (forex) traders to learn online trading.

Don’t let your trades be determined by emotions such as greed and fear. This is where the use of so-called forex trading robots may come in handy. A forex robot is software that automatically trades for you based on a strategy you have programmed into it. The software can also be used to set a stop-loss on trading, which means that the program exits the market once a certain level of loss is reached. The use of the robot removes the human factor from trading and prevents losses from worsening, since it automatically stops at a predetermined level where a human trader might continue trading in the hope of recovering his losses.

Follow the trends. There is a reason that technical analysis is popular among traders and that is the belief that history repeats itself. Hence, you improve your chances of making a successful trade if you follow the trend.

If you still feel unsure then definitely you should definitely undergo some kind of formal currency trading training. There are many currency trading courses you can take online to learn currency trading. In fact, you may be intimidated by just how many there are. Which course will best teach you how to trade currency successfully?

First, you should consider your current level of expertise. A currency trading tutorial may be aimed at novices or be designed for those who already have some experience in trading and want to deepen their knowledge. Be aware of how much you already know and what else you want to learn in order to find the course that is best for you.

Second, consider the way the currency trading training delivers its lessons. There are some courses that rely on videos while others use powerpoint presentations. Decide which format you are most comfortable with and go for that course. Or you can choose a training course that accommodates both formats.

Third, try to find a tutorial that will allow you to sample the lessons. This will allow you to see how they present their lessons and what content is included, and make it easier for you to decide if the course is right for you or not. There are three fundamental things any good trading course should include in its syllabus: money management, emotional discipline and how to develop a trading system. If the course does not include these three basics, then move on.

Finally, try online courses that are offered for free. These courses may already provide you with the information that you need. If not, then you can move on to courses that charge fees.
With all this information under your belt you should be a successful foreign currency (forex) speculator undertaking successful online trading in no time. One good thing about currency exchange trading is that you can trade while still holding on to your job. Day trading of forex currency is common among traders who work from home. Currency day trading simply means that you do your buying and selling within one trading day such that all your positions are closed by the end of trading.

Just one last piece of advice: the basic rule of speculating is never trade more than you can afford to lose. Always keep this in mind, and you’ll soon be raking in the big money in currency trading.