Currency Trading: Basics and Overview

As an investor, when you think of trading, the popular asset classes that first strike your mind are usually stocks, real estate, gold, etc. Very few realise that wealth can be generated by trading in currencies as well. Lack of enough information about currency trading, strict regulatory norms and high associated risk are some of the key reasons that have kept small investors away from the currency market. But excellent profit-making potential is now attracting more and more people towards currencies. If you are one of those who are willing to try your hand in this sector, here are some currency trading basics to help you through the process.

What is currency trading?

Currency trading, also known as foreign exchange or forex trading, refers to the buying and selling of currencies. The first thing to note here is that forex trade always happens in a pair of currencies. So, for instance, you can trade in the USD/INR pair, whose value determines the number of Indian rupees one US dollar can buy.

So, if USD/INR is 75, it means that 1 US dollar is equal to Rs. 75. You can either buy or sell the USD/INR at this price. Trades can also be done in other cross-currency pairs like GBP/USD, EUR/USD or USD/JPY. The first currency in any pair is the base currency and the second is the quote currency.

The second important thing to know before you start trading in currencies is that unlike the stock market where you can buy one unit of share, forex market deals in lots. A lot refers to a specific size of a trade an investor has to get into.

The lot size for trading in any currency pair in India is usually 1,000 units of the base currency. So, in the USD/INR pair, the lot size would be $1,000, or around Rs. 75,000 (going by the above example).

Different types of currency market

There are mainly two types of currency market -- spot market and derivatives market.

• Spot market is the purchase or sale of forex ‘on the spot’. This means that the delivery of the financial instrument takes place as soon as the trade is settled.
• Derivatives market is where the currency futures and options are traded. Currency derivatives allow you to buy/sell a currency at a future date at a previously fixed price.

In India, you can only trade in the currency derivatives market. Also, currency derivatives here are cash-settled. This means there is no actual delivery of currency on expiry of the derivatives contract. The payment is made in cash equivalent to the value of the underlying asset.

What you need to trade in forex market?

In order to start trading in the currency market, you need to open a forex trading account with a broker registered with the Securities and Exchange Board of India (Sebi). You need to submit all the KYC (know your customer) details to your broker and then deposit the required margin amount. After that, you should get the login and password details from your broker to begin trading on its proprietary forex trading platform. These custom-built forex trading platforms connect brokers with the forex market. Make sure you have a good Internet connection for minimum disruptions while trading.

Where can you trade?

Currency futures and options are traded on the National Stock Exchange of India (NSE), BSE and Metropolitan Stock Exchange. Currency trading usually happens from 9am to 5pm.

How can you benefit from currency derivatives?

Currency derivatives in India can help investors in the following ways:

• Importers and exporters, whose earnings depend on the exchange rate, can hedge against unfavourable forex rate movements by investing in currency derivatives.
• Traders can make money using currency derivatives by speculating the movement of a currency with the help of various technical indicators.
• Traders can also make money by arbitraging. As currency derivatives are traded on NSE, BSE and Metropolitan Stock Exchange, there is usually a slight difference among prices of the same currency contract on all three exchanges, creating an opportunity for traders to make profit.

Conclusion

Currency trading can reap handsome profits if you research well about the market and the financial instrument. Stay well informed to keep your risks low and returns high.