Foreign Currency Trading.

Michael Wolfe

Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.

The foreign exchange market is the market on which currencies are traded. Unlike a bourse for stock trading, which is generally open only part of the day, currency trading is going non-stop. This, plus the fact that currencies can often undergo volatile fluctuations due to sudden political and economic events, makes trading in currencies enormously risky. However, if a person is very lucky, he may be able to squeeze a profit from it.

The trading of foreign currency is the exchange of money issued in one country for money issued in another. Foreign currency trading takes place in the highly-solvent foreign exchange market. Currencies are traded for one another at exchange rates, which are relative prices determined by market supply and demand. The reasons for currency trading are usually thought to be twofold: practicality and speculation. The latter of these, speculation is believed to occupy the majority orders placed in the foreign exchange market. At a practical level, currency trading benefits countries that wish to engage in cross-border commerce or trade.

The majority of currency trading is known to be done by banks and international corporations. These companies need to convert earnings or revenues received in one currency into another. Investors also currency trade if they want to invest in the stock or bonds of another country where the rates are more attractive. Currency trading has also become popular with individual traders to profit from the relative price changes between currencies.

Currency trading takes place entirely on the computer. The currency market is also known as the foreign exchange market (Forex or FX). Online currency trading takes place all over the world, 24 hours a day, 5 days a week. When online currency trading began, only institutional investors such as investment banks and hedge funds were able to trade. But as online trading expanded, individual investors and small currencies were allowed to participate in the foreign exchange markets.

What Is Currency Trading?

According to Investopedia, "The forex market is the largest, most liquid market in the world with an average traded value that exceeds $1.9 trillion per day and includes all of the currencies in the world." The exchange of foreign currencies allows people to travel worldwide and for companies to do business on an international scale. Money or currencies is an essential component of the world's economy. Currencies play an important role in recessions, inflation or depressions. Like other forms of investment, currency trading is about supply and demand. There are a few ways to trade currencies. The spot market lets investors buy and sell foreign currencies at the current trading price. This price is based on supply and demand. The spot market is the largest currency market. Another option is the futures markets. This market lets investors buy and sell futures contracts of various popular currencies including the Swiss franc, Japanese yen or British pound. Trading futures takes place on futures exchanges including the New York Mercantile Exchange (NYMEX) and the Chicago Mercantile Exchange (CME.) According to Forex Tutorial, "Daily currency fluctuations are usually very small. Most currency pairs move less than one cent per day, representing a less than 1% change in the value of the currency." With such small price movements, the only way to make a good profit is with leverage. Leverage is an important part of the trading process. The Forex Tutorial states that leverage "can be as much as 250:1." This translates into a $1,000 investment controlling currencies worth $250,000.

Generally regarded as the most solvent of the world's financial markets, the foreign exchange market meets the needs of those who wish to obtain a specific currency in return for one they already hold. In this regard, the foreign exchange market plays a crucial role as the world's economies become increasingly interconnected. It consists of a network of numerous currency brokers located all over the world, both on the Internet and in physical locations such as banks and airports. Currency brokers offer to buy and sell the world's currencies at the market exchange rate appropriate to the currency deal.

Exchange Rates

Foreign exchange rates are simply the price of money. A given exchange rate reflects the relative market value between exactly two currencies. The rate is always expressed as the cost, in one currency, of one unit of the other currency. For instance, if the cost of one UK pound sterling, GBP, is 1.600 U.S. dollars, USD, then the USD-GBP exchange rate would be expressed as 1.600 USD/GBP, or 1.600 dollars for every one pound sterling. Furthermore, the reciprocal of an exchange rate (one divided by the exchange rate) expresses the cost of the other currency, or 0.625 GBP/USD using the first example.

Bid and Ask Prices

Traders in the foreign exchange market seldom, if ever, receive their desired currency at the exact market exchange rate. The reason is because currency brokers, as service providers, adjust the exchange rate they offer by between roughly 1 and 4 percent in order to obtain compensation. The price at which brokers sell one currency for another is called the "ask" price and comprises an upward adjustment. By contrast, the price at which brokers buy a currency is called the "bid" price and reflects a downward adjustment.

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