| August 30, 2023
Everything you need to know before investing in Foreign Exchange
Do you know which asset is traded the most or the liquid one? If you are thinking about stocks, then wait, stocks or any other stock market instruments cannot match the volume and liquidity quotient of forex trading or to be specific currency trading.
In this article, we will talk about currency trading in India, how it takes place, the most traded currencies, things you need to know about currency trading, and a lot more.
What is Forex Trading?
To begin with, let's understand what forex actually is. Forex is a word derived from two words, which are Foreign and Exchange. When currencies are exchanged for one another, it is termed as Forex. For instance, the US Dollar is exchanged for Indian Rupees.
The trading process that is buying and selling different currencies for profit-making can be described as Forex trading or currency trading.
From investors to multinational companies all take part in currency trading across the world. It is the largest market with average daily transactions of US$4 trillion.
In India and across the globe, currency trading takes place around the clock. So, there is no restriction on timing for trading.
However, the most interesting fact about forex trading is that these currencies are traded over the counter (OTC). Thus, the forex market is decentralised and anyone can trade forex irrespective of any centralised exchange unlike the stock market or commodity market.
Features of the Foreign Exchange Market in India
Now let's come to the features of the Foreign Exchange Market in India.
- Inexpensive: Currencies are traded across the globe and especially in the country for very low costs or expenses. Unlike other investment options, where there are a lot of fees and taxes to be paid, currency trading in India has lower fees. This is due to the fact that the commission, which the intermediaries charge is restricted to the spread that is the price gap between the buying and selling prices of the pair of the currencies, traded.
- Highly transparent: Transparency is another crucial factor that comes into play when trading forex. The forex market in India is highly transparent where all the traders get full access to the information and data about all the market deals and orders related to currency trading. Moreover, due to the international aspect of currency trading, transparency is maintained throughout the market. This helps the investors make wiser choices about which currencies to trade and at what prices.
- Higher leverage: For trading currencies, brokers in the country most often offer higher exposure limits to the traders. Thus, you can take more positions and increase your chances of making higher profits.
- Ease of trading and convenience: Due to the decentralisation of the forex market, there is no limitation on trading from certain devices or through any particular exchange. This makes it easier for the traders to trade the currency pairs anytime and from anywhere they want if they just have a stable internet connection. You can also set your timings according to the country of the currencies you are dealing in.
Different Forex Market
Forex market can be segregated into three sub-markets, which are –
- Spot Market: This is a market where trading is done at the ‘SPOT rate’, which means the present rate of the currency pairs. The trader has to be swift in placing orders and making transactions as prices change within the blink of an eye.
- Futures Market: Like any other futures market work where orders are placed for trading the asset at a future date or a pre-agreed price, the currency market is no different. Here traders get into standardized agreement and make transactions according to their assumptions of the price movement of the currency pairs.
- Forward market: This is similar to the futures market however, while in the futures market, the agreements are standardized, in the forward market the agreements are custom-made. The rest of the things like the pre-determined price of the currency pairs, and maturity factor remain the same.
Things you need to know before starting currency trading in India
By now, you must have got an idea of what is currency trading, so let’s understand the factors you need to keep in mind while trading currencies or forex in India.
- Commissions: Though commissions are lower for forex trading, you need to understand this as commissions are determined on the basis of the spread. The commission in the forex market is paid to the market makers.
- Trading style: Each currency is different and the risk and return quotient of each currency pair varies. So, you need to align your risk appetite and return expectations with the currency pair in order to set a trading approach or style.
- Brokerage house: Though brokers are not the intermediaries in the forex market, you need to have a trading account and thus, you need a brokerage house, which is highly reputable and offers the best platforms as currency trading requires advanced trading platforms for smoother and swifter transactions.
- Keep your emotions away: Forex trading can take a toll on you and your finances if you do not keep your emotions away from the market. As these trades are comparatively inexpensive, often traders take higher risks, which leads them to losses.
Terms to know when trading Forex
To understand how to trade currency you first need to be aware of these terminologies, which are heavily used in the forex market.
- Spread: Often called Bid-ask spread, it is the difference between the maximum amount that buyers of a currency pair are willing to pay with the minimum amount that sellers are willing to take. Suppose, the highest bid for USD/INR is Rs. 75 per USD while the minimum ‘ask’ price is Rs. 75.50. Therefore, here the spread is Rs. 0.50.
- Pip: This is described as the percentage change in a currency pair’s price. The changes in prices in the forex market are quoted in decimals and up to four decimal points.
- Currency pair: All currencies are traded in pairs. In simple terms, you trade one currency for another. For instance, in the above USD/ INR example, you are trading INR for USD.
- Lot: In the forex market in India, currency derivatives are mainly traded. Either currency futures or currency options and thus they are traded in ‘lots’ which consist of a certain number of units of currencies. For instance, a 1000 lot size means, you will be trading 1000 INR units for 1000 USDs.
How does currency trading take place?
Currencies are traded in different ways. Let's understand them individually –
- Direct trading: This is like trading stocks where you will a currency pair for say X price and if the price moves above X, then you will gain and if it moves below X, you lose.
- Trading currency derivatives: In India, and also across the globe, currencies are mainly traded as derivatives. Currency futures or currency options are traded like equity futures and equity options. If you are trading currency futures, then you are buying future contracts where you agree to pay a certain price for buying or selling the currency pair at a future date.
With currency option, you do not have the obligation but have the right to buy or sell currency pair at a pre-determined price at the time of expiry of the option contract.
How can you start foreign exchange trading?
To start currency trading in India you need to –
- Open a forex trading account with a brokerage house
- Complete KYC and get access to your trading account
- Deposit the amount into your trading account for trading and availing margin or exposure benefits
- Explore the currency market and choose the pairs of currencies you want to trade
- Do your research and then start trading.
Which are the top currencies to be traded in India?
While USD is the currency, that is mainly used for international trade, there are other currencies as well that are popular. Some of the most traded currency in the world includes
- US Dollars (USD) – It is highly liquid because it is the most popular currency across the world and is accepted as well
- Euro (EUR): In second place, is Euro, which is the most traded currency across the globe.
- Japanese Yen (JPY): It is the most traded currency in Asia
- Pound Sterling (GBP): This is the fourth most popular and traded currency across the world. It has close competition with USD, as, after USD, GBP is one of the most accepted currencies for international trade.
- Canadian Dollar (CAD): Due to its relationship with crude oil, CAD has high popularity and a close connection with USD which is obvious. It is regarded as the most important commodity currency in the world.
While the most traded currencies are the above-mentioned ones, the best currency pairs to trade depend on your trading goals, approach, and research work.
Pros and Cons of Currency Trading
- Highly liquid market
- Accessible round the clock
- Lower fees and commission
- Decentralised market
- Margin trading available
- Highly volatile
- Requires in-depth understanding of currencies, economic fundamentals, and technical analysis
- Not regulated unlike other markets
Why Forex market is booming in India?
In India, forex trading has boomed in recent years due to multiple factors which include –
- Increased use of future derivatives for trading currencies in the Indian currency market
- Retail investors can now invest in currencies, which were early restricted to HNIs, banks and institutional traders
- Increasing financial literacy rate and people becoming aware of the currency market
- Globalisation and liberalisation
Thus, we can conclude by saying, that with the right knowledge about the currency market, and trading platforms, tools and resources for trading currencies, traders nowadays can easily explore this market. However, before getting into trading currencies, one needs to learn about the fundamentals of how the forex market works.