What is Currency Trading?

Published by Thomas Herold in Economics, Trading

'Currency Trading' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Currency trading is speculating on the largest financial market on earth. Despite the fact that this is the world’s largest, most liquid, and most impressive market, many individual traders do not know much about it. This is mostly because until Internet trading became popular, access to these markets was limited.

Only the large banks, multinational businesses, and shadowy hedge funds were able to trade them. Today the currency markets trade 24 hours per day, 6 days per week. This several trillion dollar market trades on every continent. Trillions of dollars per day change hands in the foreign exchange marketplace. All of this combines to make currency trading markets the most easily accessed on earth.

This speculative currency trading is not the main reason that the Forex, or Foreign Exchange, markets exist. They were set up to help big international companies change currencies from one kind to another. Many of these corporations need to trade currency constantly to pay for such costs as international goods and services payments, payroll, and acquisitions overseas.

Despite the origins of these currency markets, only around 20% of the total market volume comes from these company trades. An incredible 80% of the daily trades in the currency markets are from speculative currency trading hedge funds, large banks, and individual investors who want to take a position on one of the major currency pairs.

Currency traders are able to engage in these markets without many of the constraints that plague the stock markets. If individuals believe that the GBP/USD pair will drop dramatically, they are able to short sell as much of the currency pair as they desire. There are no uptick rules with currency trading. There are similarly no position size limits in currency trading.

Traders could buy tens of billions of any currency pair if they had the money to cover the trade. There are also no rules on insider trading with this type of currency trading. It does not exist. Economic data in Europe is routinely leaked several days ahead of the official release date.

Another way that currency markets are different from stock markets is that there are no commissions in foreign exchange markets. All currency companies are dealers. These dealers take on the counterparty currency in any trade. They earn their money with the spreads between the bid, the cost to buy the currency pair, and the ask, the cost to sell it.

Currency trading is always done in pairs. When a trader enters such a trade, the person is long one currency in the pair and short the other currency. Selling 100,000 GBP/USD means that the trader has sold the British Pounds and bought the U.S. dollars. This means that the trader is long dollars and short pounds.

Currency valuations are expressed in pips, or percentages in point. These pips prove to be the littlest trade increment in the foreign exchange pairs. This makes one pip equal to one-one hundredth of a percent. In all pairs except the Japanese Yen, these prices are quoted out to the fourth decimal point. This means that EUR/USD would be quoted in terms of 1.1595.

There are many different minor currency pairs on the market. The majority of foreign exchange dealers only allow individuals to trade the most seven widely traded and liquid pairs. These include the four major pairs of Euro/Dollar, British Pound/Dollar, Dollar/Swiss Franc, and Dollar Japanese Yen. The other three pairs allowed are the three commodity currency pairs of New Zealand Dollar/Dollar, Australian Dollar/Dollar, and Dollar/Canadian Dollar.

Currency trading is typically done in margin type accounts. The leverage is typically 100:1 on most of the major currency pairs. This means that currency traders are able to control 100,000 of a currency pair with only $1,000 of the base unit currency.

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The term 'Currency Trading' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.