What Is Currency Trading?

What is currency trading? Simply put, it is the act of trading one currency for another. This is done when we go on vacation in another country, for example; we trade in some of our currency for the currency used in the country we are vacationing in.

Forex trading however is currency trading of a whole other order. Traders are constantly exchanging currencies for one another in order to make a profit on the constantly changing exchange rates of global currencies.

Forex trading is a lot like trading on the stock market. Unlike personal investors, who usually buy stock and then hold onto it for years, even decades, many stock traders will buy and sell stocks after a very short time in order to profit from the small changes in price which can happen very quickly.

How Does Currency Trading Work?

To explain how money is made in Forex trading, let’s see an example.

Suppose that the current exchange rate between the British pound and the Euro on the Forex market is GBP/EUR 1.120o. This means that each Pound will cost 1.12 Euros. If you predict that the Euro will rise against the Pound, then you’d sell 100,000 Pounds and buy 100,000 Euros. Then you wait for the Euro’s value to rise against the Pound. Suppose that in a few days the exchange rate is GBP/EUR 1.0600. The pound is now worth 1.06 Euros. If you sell these Euros and buy 100,000 Pounds, you’ll have made a 6% profit (minus any applicable fees)

This sounds like a huge amount of money. Who has 100,000 pounds or even dollars lying around in the bank to trade with? Not me, and I guess not you either. But fortunately, you do not have to have all that money for real. You are buying and selling at the same time, so all you need to have is enough to cover any loss that might be made before you could exit the market, if your prediction was wrong and the currency that you bought started to fall. Your broker loans you the rest.

This amount of money is called your trading margin. You need to keep this in your Forex brokerage account and it is generally around 1-2% of the value of a trade. For example, for that $100,000 trade, you’d need to have a trading margin of $1,000-$2,000

The amount you trade is determined by ‘lots’. A lot may be worth $10,000 or more depending on the currency and the broker. So if you want to trade $20,000 you would trade 2 lots and so on.

There are also what are known as limited risk accounts, where you can lose no more money than you have in your brokerage account ? this prevents margin calls. These accounts permit small investors to trade on the Forex market using mini-lots (fractions of a lot). You can trade .1 lot, or $1,000. This keeps risks low, but also lowers your profit margin (charges to trade will be greater).

An increasing number of private investors are becoming involved in currency trading. It can be more profitable than the stock market; even if you know very little about the global currency exchange, you can use a Forex robot. This is software which can trade for you based on user-defined settings. As with any kind of investment, there is risk involved and you can lose money as well as gain it. Knowing what is currency trading can help you decide whether it is an investment venue you want to become involved in.