Currency

  • An Overview on Forex Trading
    • Forex trading is the largest financial market with high trade volumes. 2013 has started with very encouraging signs in terms of volumes and performance. After a year of price swings and uncertainty, investor confidence and pre-crisis behaviour seem to return.

      The U.K. is the largest center for forex trading with the largest average trading volume at a global level. According to the Bank of International Settlements (BIS) data, the U.K. forex trading volume has increased approximately by 5.7 percent in three years (2007-2010). Also, according to the Bank of England (BOE), the average trading volume of the U.K. market reached nearly $2 trillion in the period November 2011 - April 2012. In fact, this figure is only 5 percent lower than the trading volume of the U.K forex market in 2011. Financial Services Authority UK is the governing body that regulates and oversees the financial markets, including the forex market in the UK.
  • Currency Conversion
    • The value of a particular currency is always calculated in relation to other currencies and this produces the exchange rate of the currency. In fact, the currency exchange rate is the relative value between two foreign currencies. For instance, when the exchange rate of GBP/USD is 1.58 it means that to buy $1 you need to pay £1.58. However, during the actual conversion, it is possible to get a different rate due to the bid/ask spread, which is the difference in price between the highest price that a buyer is willing to pay for a currenct and the lowest price that a seller is willing to sell. So, when you are exchanging currencies you will get a slightly higher price for the local currency from the local bank than the price you see online so that the bank realizes a profit from the bid/ask spread per transaction.
  • Spot rate vs. forward rate
    • The spot rate is the rate paid for the delivery of a currency on the spot, which normally is a couple of days after the trade. When people trade currencies on an agreed future date - typically between one and three months from the transaction date - they actually trade on a forward rate. Different interest rates result in different forward prices and in forward trading, future supply and demand may cause forward prices to deviate from any expectation
  • Examples of currency trading
    • Currency traders try to leverage the fluctuations in the relative value of each currency by buying or selling large blocks of currencies around the globe and keep the currency market relatively stable.

      To understand how currency trading works, we assume the following examples:

      1. The current exchange rate of GBP/USD is 1.58, meaning 1$ costs £1.58. If traders believe that the GBP rate will go up, they will buy $100,000 (1 lot) at 1.5820 (£158,200). If their estimate is correct and the rate goes further up, they will sell at 1.5870 to receive £158,700. This makes a profit of £158,700 - £158,200 = £500. Also, if investors believe that the British Pound is undervalued against the US Dollar, they will buy GBP and sell Dollars in order to change the exchange rate in favour of the GBP.

      2. The current exchange rate of GBP/USD is 1.58, meaning 1$ costs £1.58. If traders expect the GBP rate to decline, they will sell $100,000 (1 lot) at 1.5750 to receive £157,500. If the GBP rate declines further, they will buy at 1.5700 (£157,000). This makes a profit of £157,500 - £157,000 = £500. Also, if investors believe that the British Pound is overvalued against the US Dollar, they will sell GBP and buy Dollars in order to change the exchange rate in favour of the Dollar.

      This leverage strategy is used to meet profit margin requirements, but it may also magnify losses.
  • Who converts currencies?
    • Everybody. Importers, exporters, tourists and governments buy and sell currencies in the forex market, either in large or small blocks. Investors who favour currency trading set an investment strategy and do not deviate for emotional reasons. However, they take into consideration any market fluctuations, speculation and trends. Speculation is a core element of currency trading as, typically, traders speculate the future movements of a currency and sell or buy based on this speculation. In doing so, they affect national currencies and national economies (e.g. the latest cases of Greece and Spain with high speculation on bonds).

      In short, the forex market is mostly open to large financial institutions and multinational enterprises. However, as a result of advanced technology, individual investors and laymen can convert currencies and, more importantly, trade currencies in the largest foreign exchange markets of the world. As an individual investor, what you need to focus on is to avoid emotional trading and stick to your strategy.