A Forex Trading scenario:
An Indian company is involved in a considerable amount of business in Singapore. Naturally, a lot of their transactions will take place in Singapore dollars. But the Indian company would hedge against a fall in the relative value of the Singapore dollar.
What do they do?
They buy the Currency pair INR/SGD (Indian Rupee vs. Singapore dollar).
But first, let’s understand Forex trading and how Forex trading work.
Table of Contents
What is Forex Trading?
Forex trading or forex exchange is the exchange of one currency for another. This exchange takes place at an agreed rate which is known as the exchange rate.
Foreign Exchange Market is a global marketplace where currency exchange takes place and it is open 24*7.
How does Forex trading work?
Here’s a brief overview of how Forex trading works:
- Currencies are always traded in pairs, such as the EUR/USD (Euro/US Dollar). When you buy one currency, you are simultaneously selling another currency.
- The exchange rate between two currencies determines the value of each currency relative to the other. These exchange rates are constantly fluctuating, based on various economic and political factors.
- Traders can buy or sell a currency pair in order to take advantage of these fluctuations in exchange rates. If a trader believes that the value of one currency will rise relative to another, they can buy the currency pair. If they believe that the value of one currency will fall relative to another, they can sell the currency pair.
- Forex trading is typically done through a broker or market maker who facilitates the trades. Traders can use a variety of tools and techniques to analyze the market and make informed trading decisions.
- Forex trading can be highly volatile and risky, and traders should be prepared to handle potential losses. It’s important to have a solid understanding of the market and to develop a trading strategy that suits your individual goals and risk tolerance.
Types of Forex Market
- Spot Forex Market: The spot Forex market, also known as the cash market, is where currencies are bought and sold at the current market price, which is determined by the supply and demand for that particular currency. The transactions in the spot Forex market are settled immediately, usually within two business days.
- Forex Futures Market: The Forex futures market is a market where traders can buy or sell a contract that specifies the price at which a particular currency will be exchanged at a future date. The futures contracts are traded on a centralized exchange and have standardized contract sizes and expiry dates. The Forex futures market is used by traders and investors to hedge against currency risk or to speculate on future price movements of a currency pair.
How are currencies traded?
A three-letter code is attributed to each currency while trading. For example, the U.S. dollar is marked as USD.
Forex trading is expressed in a combination that involves two currencies that are being traded. For example,
EUR/USD
This means buying Euros and selling US Dollars.
What is Base and Quote Currency?
A Forex trade involves a pair of currencies. It involves a currency that is being sold in order to buy another currency.
So in the case of EUR/USD, EUR is the base currency and USD is the quote currency.
This further means that if EUR/USD is trading at 1.4678 then one Euro is worth 1.4678 dollars.
| EUR | USD |
| Base Currency is the currency you are buying in the forex trade | Quote Currency is the currency you are selling in the forex trade |
How to start Forex trading
- Learn the basics: Before you start trading, it’s essential to have a good understanding of how the Forex market works, including the terminology, currency pairs, and trading strategies. There are many online resources, courses, and books that can help you learn the basics of Forex trading.
- Choose a reputable broker: The broker you choose will be responsible for executing your trades and managing your account. Look for a broker that is regulated, has a good reputation, and offers competitive trading conditions, including low spreads and high leverage.
- Open a trading account: Once you have chosen a broker, you’ll need to open a trading account. The account opening process usually involves providing personal and financial information, and in some cases, submitting documents to verify your identity.
- Fund your account: You’ll need to deposit funds into your trading account to start trading. Most brokers offer a variety of payment methods, including bank transfers, credit cards, and e-wallets.
- Start trading: Once you have funded your account, you can start trading. Use the trading platform provided by your broker to place trades, monitor your positions, and manage your risk.
- Practice with a demo account: Many brokers offer demo accounts that allow you to practice trading with virtual money before you start trading with real money. This is a great way to gain experience and test your trading strategies without risking your own capital.
Forex Terminology
- Currency Pair: A currency pair is the combination of two currencies that are traded against each other in the Forex market. For example, EUR/USD is the Euro/US Dollar currency pair.
- Bid Price: The bid price is the price at which a trader can sell a currency pair.
- Ask Price: The ask price is the price at which a trader can buy a currency pair.
- Spread: The spread is the difference between the bid price and the ask price of a currency pair. It represents the transaction cost of trading.
- Pips: A pip is the smallest unit of price change in a currency pair. It stands for “Percentage in Point.”
- Leverage: Leverage is the amount of money that a trader can borrow from their broker to increase the size of their trading position.
- Margin: Margin is the amount of money that a trader must deposit with their broker to open and maintain a trading position.
- Stop-Loss Order: A stop-loss order is an order placed by a trader to automatically close a position when the market moves against them, to limit potential losses.
- Take-Profit Order: A take-profit order is an order placed by a trader to automatically close a position when the market moves in their favour, to lock in profits.
- Margin Call: A margin call occurs when a trader’s account falls below the minimum margin requirements set by their broker, and the trader is required to deposit additional funds to maintain their open positions.
Forex Trading Strategies in India
- Trend Trading: This strategy involves identifying the direction of the trend in the market and trading in the same direction. Traders use technical analysis tools such as moving averages and trendlines to identify trends.
- Range Trading: This strategy involves identifying a range-bound market, where prices are moving between a support and resistance level. Traders can buy at the support level and sell at the resistance level.
- Breakout Trading: This strategy involves identifying a price level where the market is likely to break out of a range and trade in a new direction. Traders can place buy or sell orders at the breakout level.
- Scalping: This strategy involves making multiple trades throughout the day, with the aim of profiting from small price movements. Scalping requires a lot of discipline and quick decision-making skills.
- News Trading: This strategy involves trading based on news and economic events that can affect the Forex market. Traders can use a calendar of upcoming events to identify potential trading opportunities.
- Position Trading: This strategy involves holding a position for a longer period, from several days to several weeks or months. Position traders use fundamental analysis to identify long-term trends in the market.
Tips for successful Forex trading in India:
1. The right broker will never break your trust!
The most important step to successful forex trading is to select a trustworthy broker who has been authorised by SEBI. Your broker should provide you with high leverage ratios, lower spread and brokerage charges.
2. What’s your game plan? Strategy
Forex trading demands a strategy. A strategy that clears out your end goals via the trading session, your profit goals, and ideas about your stop-loss. It is also essential to have a clear idea of your risk tolerance levels.
3. Market weather prediction:
The Forex market is volatile. Observing the market before investing is an essential step for successful forex trading especially if you are new. The Forex market is prone to fluctuations based on geopolitical tensions and other factors.
4. Start small and slow:
One of the most important steps to start forex trading is to start small. Smaller investments allow you to realise your risk appetite. While you invest it is essential for you to understand the leverage, leverage ratio, and market movement, determining your stop-loss/profits.
5. Stop-Loss:
Stop-loss is the most important element of Forex Trading. Being a trader would invite a number of times when you might have made wrong decisions but how will you protect all your money?
Enter Stop-Loss.
Mr Bajaj decides to become rich by intraday trading in the GBP/INR futures. He decides to buy 13 lots against Rs 10,000 straight into his trading account. He gets a leverage of 123 times. But he notices that the GBP/INR starts depreciating, and he worries about losing his money.
Now, Mr Bajaj is left with 2 options:
- Have patience and pray!
- Put a stop-loss and book losses
If Mr Bajaj went with the first option, he would have lost almost all his money by the end of the trade as the GBP/INR fell 0.73 paise in the day. So, he would have lost his whole capital.
But Mr Bajaj being a smart forex trader decides on putting a stop loss at 94.70. This helped him cut his loss to Rs 1,657 instead of losing the entire Rs 10,000.
Foreign Exchange management techniques for Your Business:
The main roadblock to successful overseas business operations is a lack of awareness and constant fluctuations in currency values. Proper foreign exchange management techniques can be very helpful to ensure the business is on the track. Here are a few steps that may lead an enterprise that way.
1. Approach a bank suitable for your business
This is the foremost step in bringing your Forex management on track. Although banks might offer similar services, it is always advised to compare rates with the mid-market rate which is also known as the actual exchange rate. this will be easily available on the Internet.
Next is the commission fee. Never get deceived by the commission fee charged by banks. Though many banks offer a 0% fee, it is not practical and one should understand that the fee may be in some other hidden form in such cases.
Although usually, you can find that the banks operating online and having a transparent rate sheet are trustworthy, as they do not try to manipulate the customers.
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2. Focus on the Forex provider
While there are many Forex providers offering a myriad of services, one should be careful in choosing them according to the nature of their business transactions.
Eg: it would not be so beneficial to choose a Forex provider with a better price, but supports only a few currencies if your Forex transactions are from all around the globe.
3. Know where your money is going
Focus on the below factors to have a fair idea of what you are paying for:
- Dumping: This is the most commonly used deceptive technique in the Forex market where they lure customers initially by offering unimaginably low rates and then they start charging additional costs on future transactions without any intimation.
- Selective Exchange Rate Adjustment: It is obvious for the service providers (banks, FX providers) to find opportunities to benefit from the market conditions, but transfer the potential losses to the customers. In the highly volatile foreign exchange market with the exchange rates updating almost constantly, there will be cases where the updated exchange rate can either benefit the bank from the agreed exchange rate or in some cases, can also be a loss factor for them.
- Spread: Spread is the difference between the exchange rate offered by the bank and the real exchange rate or the mid-market rate. Thanks to the continuously upgrading technology, now the mid-market rates are easily available to everyone on the internet, which was not used to be the case earlier.
Hence, it is not easy nowadays for banks or brokers to take advantage of the spread.
4. Maintain an account in the main currency
The main currency is usually the currency in which the majority of the transactions occur. In many ways, it is beneficial to maintain an account in the main currency.
With most of the transactions occurring in the main currency, this account prevents loss in the form of spread and protects the firm’s revenue from the volatile currency exchange rates. Also, one can always take credit in the main currency by maintaining a bank account operating in that currency. This also saves time by avoiding unnecessary intermediary steps like currency conversion and transfer.
5. Know better about the currencies
The focus on international transactions should be on saving as much as you can from the charges like spread. Hence, major currencies are always a better bet. These major currencies like USD, EUR, and GBP are traded in mass and have high liquidity with low spread.
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6. Risk is inevitable, but can be covered through Hedging
Business is always prone to financial risks. International trade is no exception. Highly volatile foreign exchange rates demand hedging of the same. Hedging is a process of minimising risk by using financial instruments like future, forwards, options and swaps.
Pros and Cons of Forex Trading
- High liquidity: The Forex market is the largest financial market in the world, with high liquidity. This means that traders can easily buy and sell currencies at any time, without worrying about price movements or the availability of buyers or sellers.
- High leverage: Forex trading allows traders to use high leverage, which means they can control a large position with a relatively small amount of capital. This can potentially lead to higher profits.
- 24-hour market: The Forex market is open 24 hours a day, five days a week, which means that traders can trade at any time, from anywhere in the world.
- Low transaction costs: Forex trading generally has lower transaction costs than other financial markets, such as stocks or futures. Most Forex brokers do not charge commissions, and the transaction costs are typically built into the bid-ask spread.
- Diversification: Forex trading provides an opportunity to diversify an investment portfolio, as it is a separate asset class from stocks, bonds, and commodities.
Cons:
- High risk: Forex trading is a high-risk activity, as prices can be volatile and unpredictable. Traders can lose their entire investment if they do not manage their risk properly.
- Market manipulation: The Forex market is not regulated in the same way as other financial markets, which can lead to potential market manipulation by large financial institutions or governments.
- Technical complexity: Forex trading requires a good understanding of technical analysis, charting, and trading platforms, which can be complex and overwhelming for beginners.
- High emotions: Forex trading can be emotionally challenging, as traders may be influenced by fear, greed, and other emotions that can lead to irrational trading decisions.
- Limited transparency: The Forex market is decentralized, which means that there is limited transparency compared to other financial markets. Prices can vary between different brokers and liquidity providers.
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Frequently Asked Questions
What is Forex trading?
Forex trading or forex exchange is the exchange of one currency for another. This exchange takes place at an agreed rate which is known as the exchange rate.
Can you trade cash in Forex markets?
Cash or delivery trading is prohibited and illegal in India. You can only trade via currency derivatives.
Is Forex profitable?
Yes. The Forex market is the most liquid market in the world and is rich with money-making opportunities. With great market perception, a good broker and proper risk management in place, the forex markets can be profitable.
Which currency pairs are legal in India?
In India, legally you can trade in only 7 currency pairs i.e. USD/INR, JPY/INR, GBP/INR EUR/INR, EUR/USD, GBP/USD and USD/JPY.
