What is Currency Trading?
When you open a currency trade in the Currency Trading market, you pick two currencies, and buy one and sell the other at the same time. For example, if you have an EUR/USD pair quoted at 1.07905, this means that if you sell one euro, you can buy 1.07905 dollars. To close your trade, you then sell the currency you originally purchased, while simultaneously buying the currency you sold in the first transaction. Investors hope to make a profit by timing the opening and closing of trades for times when they have correctly price read trends.
2 Currency trading, at its heart, involves rating the economy of one country against another. When the economy of a country or region is doing well, prices for its currency go up. When the economy of a country or region is doing poorly, prices for its currency go down. Currency Trading traders keep constant track of different countries and/or regions to get an idea of whether their currency prices are trending up or down. Although there are dozens of currencies that you can potentially trade, the vast majority of Currency Trading transactions involve the currencies of one of eight different countries or regions: America, the Eurozone (including France, Germany, and Spain), the U.K., Switzerland, Japan, Australia, New Zealand, and Canada.
How Does Currency Trading Work
The Currency Trading market has two tiers of providers who can grant access to currency traders: the Interbank Market, also known as Tier I liquidity providers; and the Currency Trading Dealers, or Tier II liquidity providers. Tier I institutions include national Central Banks that handle the reserve requirements for major countries and receive the lowest rates on trades due to extremely high volume. These providers process approximately 50% of Currency Trading transactions. Tier II institutions serve as the intermediary brokers between the Interbank Market and the retail trader.
A Brief History of Currency Trading
Originally, only Tier I providers were eligible to participate in the currency market, because retail traders could not access the tools needed to buy and sell through the Central Banks, and there was a lack of brokers who were willing to pool orders from multiple traders to take advantage of these opportunities. However, in the late 1990s, internet access became more widespread. Eventually, private individuals heard about the profit potential of foreign exchange transactions and demanded a way to compete. This led to the creation of a number of brokerages who developed electronic currency platforms which make it possible to trade online.
Risks of Currency Trading
When considering whether to enter into the Currency Trading market, traders should keep in mind that there are a number of hidden costs. There is always a difference between the buy price and the sell price of a currency pair. This difference is called the spread. To make any profit, you need to wait until the price has moved enough to cover the spread. Also, when a Currency Traiding trade is held after 5pm Eastern time, you may encounter rollover. This is the interest that the Central Banks associated with the currencies you are trading has said is owed or should be paid for that day. If you do not close your trades in time, or if you do not pay attention to the interest due, you can find rollover costs eating into your profits.
Another risk of Currency trading is volatility. Currency Trading investors react quickly to market news, and even though the online trading systems are extremely fast, sometimes they can’t keep up with prices as they change within microseconds. This means that it may not be possible to close a trade without losing more than your initial investment, even if you are diligent about using a protection feature called a stop-loss, which tries to automatically close trades at a point you select. Most Currency Trading brokers make sure clients are aware that they can lose more than their initial investment.
Why Trade Currencies Using Online Trading
One way to make currency trading easier is by using CFDs for trading currencies. You simply enter a contract for difference, specifying the direction in which the two currencies will develop. The sum initially required to invest is significantly lower, than in conventional currency trading, yet the profit you will collect when your predictions are met is the same. CFD trading is fast and you can close any position whenever you feel like you made enough profit, the direction is going to reverse or the direction you choose was wrong.