WORLD OF CURRENCY TRADING

 Currency trading may only seem like something of necessity when one travels from one country to another. This lesson will discuss currency trading as a profitable venture, and how owners/managers of such businesses deal with the fluctuations that can occur in currency valuation.

Currency Trading

Currency trading, often referred to as foreign exchange or Forex, is the purchasing and selling of currencies in the foreign exchange marketplace, done with the objective of making profits. It is referred to as 'speculative Forex trading.' Forex trading is the largest market in the world, with nearly $2 trillion traded on a daily basis, with quick growth projections. The main factor that differentiates currency trading from other types of trading is its liquidity.

How Does the Forex Work?

Currency trading is usually done through brokers and market makers. Investors who trade this way depend on the brokers to place a corresponding trade on the international market. For example, the currency exchange of US dollars to Jamaican dollars is US$1 = JA$114.59, so US$2,000 can earn the investor JA$229,180, who can then in turn reinvest.

Forex trading occurs when the buying and selling of one currency for another takes place at the same time. Together, the two currencies form a currency pair. Each one is represented by three letters, with the first two letters representing the name of the country, and the third letter representing the name of the currency, as shown below:

• United States Dollar: USD
• Eastern Caribbean Dollar: ECD
• Australian Dollar: AUD
• Japanese Yen: JPY

The Language of Currency

When writing currency pairs, the market uses the following format: EUR/USD = 1.23700, rather than expressing them this way: EUR$1 = USD$1.23700. In the preferred format, the base currency is shown on the left, the Euro in this case, and the quote currency is shown on the right, which is the US dollar.

When investors are selling, the exchange rate of the foreign currency tells them how many units of the quote currency they will get for one unit of the base currency. Traders make decisions to buy if they think that the value of the base currency might increase. In the example, traders would purchase the US dollar with the Euro if they expect the value of the US dollar to increase to $1.31. The change that takes place is how the investor makes a profit.

Making Money

Let's imagine that a hypothetical investor, Laura, buys US$100,000 at $1.23700 and then holds on to it until its value increases to $1.31; her profit would be $7,300, as shown in the calculation below:

(100,000 x 1.31) - (100,000 x 1.23700) = $7,300.

Laura makes two trades, one to purchase the US dollar, then another to sell it, which yields $7,300 in profit. Ultimately, the investor is counting on fluctuations in values of currencies.

Currency Fluctuation Causes

There are many factors that can contribute to changes in the value of a currency. Some of these factors include terms of trade, differences in inflation rates, and public debt. Let's take a look at each one of these factors.

A Few Basic Terms in Currency Trading

• • Major Currency Pair
    When you trade currency pairs, you will encounter six major currency pairs in your daily trades. These include the  and EUR/USD. Major currency pairs include one major currency against the US dollar. Simply put, these are the most actively traded currency pairs in the world, and they offer the greatest liquidity. Their volatility is consequently lower, since – given the large number of traders involved – the consensus on a given price is much stronger and harder to disrupt.

• • Minor Currency Pair
    Minor Pairs by contrast are those currency pairs that are less traded than the major currency pairs. They are less liquid than the major currency pairs and they often have wider spreads. As a general rule, minor currency pairs are any pairs other than the six major currency pairs listed above. Here at AvaTrade, we’ve got a wide selection of minor currency pairs for you to trade.

• Exotic Currency Pair
  Exotic currency pairs typically include a currency from an emerging market country. The reason that they are called exotic currency pairs has nothing to do with the location of the country, but rather the additional challenges involved in trading these currency pairs. Exotic currency pairs are generally illiquid, with wider spreads and fewer market-makers. Examples of exotic currency pairs include the South African Rand (ZAR), the Hong Kong Dollar (HKD) and the Mexican Peso (MXN).