Forex Trading

How Currency Trading Works

Currency trading involves speculating on whether a currency will increase or decrease in value relative to another currency. Trading is generally done is through derivatives (securities) that track the value of the underlying currency. This means you don't need to own the currency you are investing in.

The foreign exchange market turns over approximately 400 billion dollars – per hour. This makes currency trading the world's largest financial market. It is estimated that about 90% of this is speculation, and the majority of trading is conducted by companies, institutions, and governments. Currency trading is primarily done against the USD, Euro, and Yen.

Currency Trading is Done in Pairs

Unlike stocks and similar securities, currency trading is done in pairs. A trade always involves selling one currency while simultaneously buying another. With the currency pair EUR/USD, Euros are sold to buy USD.

However, you do not need to have access to these currencies to be able to trade in pairs. This is done by trading through various certificates, contracts, and options.

Cryptocurrencies are Growing

In recent years, trading in cryptocurrencies has increased extremely sharply. At the beginning of 2020, the market cap (total value of the 100 largest cryptocurrencies) was a total of 191 billion dollars.

Cryptocurrencies are also traded in pairs. Similar to other currency trading, the easiest way to invest in cryptocurrencies is through certificates and contracts. However, if you wish to use the cryptocurrency as a means of payment, trading must be done directly in the desired currency.

Primarily Traded with Derivatives

For speculative currency trading, there is no reason to exchange and own the currency you are investing in. Instead, trading is done using various derivative instruments. Examples include barriers, CFDs, and options.

These are securities that track the value of the underlying asset. They can be traded with limit orders, stop-loss, and other financial functions that facilitate risk management.

• Barriers – An option that tracks the value of the underlying asset
• Vanilla Options – A contract that gives the right (but not the obligation) to buy/sell at a certain value on a predetermined date.
• CFD – A contract based on the difference between the opening and closing price of the underlying asset.

Changes are Quoted in Pips

Value changes in currency pairs are generally quoted in Pips. The number of Pips the value has changed is indicated by the fourth decimal place.

Example: The currency pair EUR/USD is trading at 1.0951 and changes over a day to 1.0949. In this case, a decrease of 2 Pips has occurred.

Increase the Opportunity/Risk with Leverage

Since there are generally very small percentage changes in the currency market, leverage is often used. There are brokers that offer up to 400:1 leverage, which means a minimal movement of 0.1% corresponds to 40%. But it also means that the downward movement is just as sharp.

Profit from a Currency's Rise – or Fall

By trading with derivatives, it is possible to make money on both a currency's rise and fall. This is done by "going long" or "going short".

Going Long

"Going long" means investing in a currency that you believe will increase in value relative to the currency it is traded against.

Going Short

"Going short" means investing in a currency that you believe will decrease in value relative to the currency it is traded against. If the currency goes down 5%, it will result in a 5% profit for the investor.

What Affects a Currency's Value?

Balance of Trade

The balance of trade affects the demand for a specific currency. High demand for a currency can drive its price up.

Future Confidence

What primarily determines a currency's value is investors' confidence in the future and their assessment of the country's economy. Factors such as GDP, industrial growth, and political decisions play a role here. Between 90 and 95% of trading is based on speculation, whether short-term or long-term. In long-term speculation, it is precisely the future assessment of the currency's value that forms the basis for investments.

Interest Rates

The interest rate set by a country's central bank forms the basis for the deposit and lending rates at commercial banks. Countries with high interest rates offer better returns, which in turn increases demand for and the value of their currency. At the same time, the interest rate must be weighed against the risk. In several countries with weak economies, the interest rate can be around 10% without significantly affecting the country's currency. In this case, investors consider the risk to be simply too high in relation to the potential return.

How to Get Started with Currency Trading

1. Open an account with a currency broker

   It is free to open an account with most reputable currency brokers. Generally, all that is required is an email address and personal details.

2. Practice with demo money until you understand trading

   Most offer a "demo" account where you can trade with virtual money. Learn how to use Stop-Loss, Limit orders, and other features.

   Even when you start trading with real money, it's easy to go back to the demo account. If you encounter a new feature or trade new securities, test them first with virtual money.

3. Learn about the different costs

   The most common cost is the spread, i.e., the difference between the buy and sell price. In classic currency trading, it is extremely small, but in cryptocurrency trading, it can even be a few percent. When trading CFDs, for example, there may also be overnight and weekend fees. This is also clearly shown when trading with a demo account.

4. Deposit money and trade "for real"

   When you feel confident, you can deposit money and start trading with real capital.

   Always make sure to verify your account before depositing money. Verification means submitting a copy of your ID documents as proof of who you are. It is often possible to deposit money before verification is complete – but verification is then required to make a withdrawal. If there are problems with verification, your deposited funds can become "locked". This is a problem that can be avoided if verification is completed before making a deposit.

5. Follow others and learn as you go

   Follow blogs, news, or podcasts in the field to learn more about trading. But above all – experiment in small steps. Create a strategy and stick to it no matter what happens. It is especially when emotions take over that poor investment decisions are made.