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Currency trading is buying and selling money, where traders purchase one type of currency using another. Profit is made when one currency is underpriced relative to another, which can create arbitrage opportunities.
Currency trading takes place on the foreign exchange market (also known as Forex, or FX market). FX has extremely high liquidity, which ensures the ease and speed of trades. As it is relatively easy to trade currency online, currency trading has become both widespread and straightforward. Currency has grown into the largest asset class in existence today, both in terms of geographical distribution and trading hours.
The value of a currency is expressed relative to another using exchange rates. As with any asset class, a currency becomes more valuable when demand for it is high and supply is low. Demand for a particular currency is dependent on that nation’s unemployment, GDP and business activity. Exchange rates are contingent on both economic and political factors. For instance, a country’s inflation rate, interest rate, industrial production, and monetary flows will impact the current exchange rate (also known as the spot rate). Currency trading for a living requires knowledge of both the internal economic situation of a country, and a macro level understanding of one economy relative to another.
Speculative demand also causes exchange rate fluctuations. Investors develop expectations for a currency’s value based on their expectation of interest rate movements. Often, currency traders will borrow money in a currency with a low interest rate in order to purchase another currency with a higher interest rate. This is called a carry trade. Retail currency trading is largely dependent on speculative demand, rather than the demand for a currency within a country (called transaction demand).
While currency trading is ubiquitous and all currencies may be traded, only a few pairs are commonly exchanged. These major currency pairs, or “majors,” make up 90% of trades in the foreign exchange market. Major currency pairs include:
- EUR/USD (Euro to US dollar)
- USD/JPY (US dollar to Japanese Yen)
- GBP/USD (Pound sterling to US dollar)
- USD/CHF (US dollar to Swiss Franc)
- AUD/USD (Australian dollar to US dollar)
- USD/CAD (US dollar to Canadian dollar)
- NZD/USD (New Zealand dollar to US dollar)
These combinations are used to create the desired exchange. For instance, to trade EUR/CAD, an investor would need to trade EUR/USD then USD/CDN. It is possible that currency trading may require several transactions before the desired exchange is concluded. This is true especially when using less common currencies, which can only be exchanged via more prevalent currencies. The majors are used because they are less volatile, and arguably more predictable.
Currency trading does not take place through a regulated exchange. There are neither limits to how much can be traded, nor upticks rules for short sales. Insider trading does not exist. While this may seem both confusing and risky, self-regulation provides effective control in the foreign exchange market. Currency trading is well established and carries a high risk to investment capital but also has the potential to be highly lucrative, especially when leverage is used.
Forex trading signals can be provided. They are available to supplement your currency trading on a two-week trial basis, at no cost.