Currency Trading (Forex Trading)

1. Introduction to Currency Trading

Currency trading, also called foreign exchange trading or forex trading, is the global marketplace where national currencies are bought and sold against each other. It is the largest and most liquid financial market in the world, with a daily trading volume exceeding $7 trillion (according to BIS 2022 report).

Unlike stock markets, which operate in specific exchanges (like the NYSE or NSE), forex is a decentralized market that operates 24 hours a day, five days a week, spanning across global financial hubs: Sydney, Tokyo, London, and New York.

The main purpose of forex trading is:

Facilitating international trade and investment – businesses need currency exchange.

Speculation and profit-making – traders attempt to profit from price fluctuations.

Hedging – corporations and investors manage currency risk.

2. History of Currency Trading

To understand modern forex, let’s go back in time:

Gold Standard Era (1870s – 1914): Currencies were pegged to gold. Stable but restrictive.

Bretton Woods System (1944 – 1971): Post-WWII, the US dollar was pegged to gold, and other currencies were pegged to the dollar. This system collapsed in 1971 when the US ended gold convertibility.

Free-Floating Exchange Rates (1971 onwards): Major currencies started floating freely, driven by supply and demand.

Digital and Online Forex (1990s – present): With the internet and trading platforms, forex became accessible to retail traders worldwide.

Today, forex is a technology-driven global marketplace where even small investors can trade currencies with a click.

3. Basics of Currency Pairs

Currencies are traded in pairs, since one currency is exchanged for another.

Example: EUR/USD = 1.1000

This means 1 Euro = 1.10 US Dollars.

If you think the Euro will strengthen, you buy EUR/USD.

If you think the Euro will weaken, you sell EUR/USD.

Categories of Currency Pairs:

Major Pairs: Most traded, always include the USD (e.g., EUR/USD, GBP/USD, USD/JPY).

Minor Pairs (Crosses): Don’t include USD (e.g., EUR/GBP, AUD/NZD).

Exotic Pairs: Combine a major currency with one from an emerging economy (e.g., USD/INR, EUR/TRY).

4. How the Forex Market Works

Forex operates on an OTC (Over-the-Counter) model – no central exchange. Instead, it works via a network of:

Banks & Central Banks (liquidity providers).

Hedge Funds, Corporations, and Governments (large participants).

Retail Brokers who provide platforms for individuals.

Market Sessions:

Sydney Session: Opens the week, low liquidity.

Tokyo Session: Active Asian trading.

London Session: Very liquid, overlaps with Asia and US.

New York Session: High volatility, overlaps with London.

Because of these time zones, the forex market is effectively open 24/5.

5. Key Players in Currency Trading

Central Banks: Control money supply and interest rates, e.g., US Federal Reserve, ECB, RBI.

Commercial Banks: Provide liquidity, facilitate global trade.

Hedge Funds & Institutions: Speculate with billions of dollars.

Corporations: Hedge currency risk for imports/exports.

Retail Traders: Individuals trading via brokers.

6. Why Do People Trade Currencies?

Speculation: Profit from price changes.

Hedging: Protect against currency fluctuations.

Diversification: Alternative to stocks and commodities.

Accessibility: Low entry cost, leverage availability.

7. Key Concepts in Forex Trading
(a) Bid & Ask Price

Bid Price: Price at which market buys from you.

Ask Price: Price at which market sells to you.

Spread: Difference between bid and ask (broker’s fee).

(b) Pips & Lots

Pip (Percentage in Point): Smallest price movement (e.g., 0.0001 in EUR/USD).

Lot: Standard unit of trading (100,000 units of base currency).

Standard Lot = 100,000

Mini Lot = 10,000

Micro Lot = 1,000

(c) Leverage & Margin

Leverage: Allows traders to control large positions with small capital (e.g., 1:100).

Margin: Deposit required to open a leveraged trade.

(d) Long & Short Positions

Long (Buy): Betting on currency appreciation.

Short (Sell): Betting on currency depreciation.

8. Fundamental Analysis in Forex

Fundamental analysis examines economic, political, and financial factors that influence currencies.

Key Drivers:

Interest Rates: Higher rates attract capital → stronger currency.

Inflation: High inflation → weaker currency.

GDP Growth: Strong economy → strong currency.

Employment Data: (e.g., US Non-Farm Payrolls).

Trade Balance: Surplus strengthens currency, deficit weakens it.

Geopolitics: Wars, elections, policy shifts affect currencies.

Example: If the US Federal Reserve raises interest rates, the USD often strengthens.

9. Technical Analysis in Forex

Traders also rely on charts and indicators to predict price moves.

Common Tools:

Candlestick Patterns: e.g., Doji, Engulfing.

Support & Resistance Levels.

Trendlines & Channels.

Indicators: Moving Averages, RSI, MACD, Bollinger Bands.

Chart Patterns: Head & Shoulders, Triangles, Flags.

Technical analysis helps traders time entries and exits more precisely.

10. Types of Currency Trading
(a) Spot Trading

Immediate exchange of currencies at current market price.

Most common type for retail traders.

(b) Forward Contracts

Agreement to exchange currency at a future date, fixed rate.

Used for hedging.

(c) Futures Contracts

Standardized contracts traded on exchanges (e.g., CME).

Regulated and transparent.

(d) Options

Right (but not obligation) to buy/sell currency at a set price.

Used for hedging and speculation.

(e) CFDs (Contracts for Difference)

Popular in retail forex.

No physical delivery of currency, only speculation on price changes.

Conclusion

Currency trading is a dynamic, global, and highly liquid market that offers immense opportunities and risks. It plays a vital role in the global economy by enabling trade, investment, and financial stability.

For traders, success in forex requires:

Solid understanding of fundamentals and technicals.

Strict risk management.

Strong psychological discipline.

While the potential rewards are high, forex trading is not a shortcut to riches. It’s a skill-based profession that requires patience, practice, and continuous learning.