What Is Currency Trading?
Trading in any investment market is challenging, as evidenced by most beginning traders losing money. However, success can be found with enough of the proper education, practice, and experience. So, what is currency trading, and is it right for you?
Definition and Examples of Currency Trading
If you trade currency, you’ll do it on the foreign currency exchange or Forex market. As with the travel example, you use one country’s money to buy another country's currency. You acknowledge and sell currency based on the direction you think each currency will trend about one another.
A currency pair is simply the two currencies you trade against one another side by side, identified as a three-letter abbreviation for each currency. So you’ll typically see the United States dollar/Canadian dollar pair represented as (USD/CAD). The yen and the euro pair are represented by (JPY/EUR).
When you trade a currency pair, you’ll run into terminology similar to what we commonly use with stocks. Each currency pair has an ask and a bid. The ask represents what it would cost you to purchase a currency, whereas the bid is what you’ll receive if you sell the money. The difference between the bid and ask is the spread.
You’ll see currency pairs quoted using “pips” or percentage in points. Typically, a pip is equal to 1/100 of 1 percent or equivalent to 0.0001. We use the pip to calculate the bid/ask spread
You make or lose money based on the buy/sell decision and the direction your currency pair moves.
Pairs and Pips
All currency trading is done in pairs. Unlike the stock market, where you can buy or sell a single stock, you have to buy one currency and sell another currency in the forex market. Next, nearly all currencies are priced out to the fourth decimal point. A pip or percentage is the smallest increment of trade. One pip typically equals 1/100 of 1%.
Currency is traded in various sized lots. The micro-lot is 1,000 units of a coin. If your account is funded in U.S. dollars, a micro lot represents $1,000 of your base currency, the dollar. A mini lot is 10,000 units of your base currency, and a standard lot is 100,000 units.
A pip (percentage in point) is the smallest increment of trade. One pip typically equals 1/100 of 1% or the number in the fourth decimal point. Most currencies are priced out to the fourth or fifth decimal point. Exceptions to this rule are currency pairs that include the Japanese Yen (JPY) as the quote currency. These pairs typically price out to two or three decimal places, with a pip being represented by the second decimal place.
Retail or beginning traders often trade currency in micro-lots because one pip in a micro lot represents only a 10-cent move in the price. This makes losses easier to manage if a trade doesn't produce the intended results. In a mini lot, one pip equals $1, and that same pip in a standard lot equals $10. Some currencies move as much as 100 pips or more in a single trading session, making the small investor's potential losses much more manageable by trading in micro or mini lots.
Far Fewer Products
The majority of the volume in currency trading is confined to only 18 currency pairs compared to the thousands of stocks available in the global equity markets. Although there are other traded pairs outside of the 18, the eight currencies most often traded are the U.S. dollar (USD), Canadian dollar (CAD), euro (EUR), British pound (GBP), Swiss franc (CHF), New Zealand dollar (NZD), Australian dollar (AUD) and the Japanese yen (JPY). Although nobody would say that currency trading is easy, having far fewer trading options makes trade and portfolio management an easier task.
What Moves Currencies?
An increasing amount of stock traders are taking an interest in the currency markets because many of the forces that move the stock market also move the currency market. One of the largest is supply and demand. When the world needs more dollars, the value of the dollar increases, and when there are too many circulating, the price drops.
Other factors like interest rates, new economic data from the most significant countries, and geopolitical tensions are just a few events that may affect currency prices.
The Bottom Line
Like anything in the investing market, learning about currency trading is easy but finding the winning trading strategies takes a lot of practice. Most forex brokers will allow you to open a free virtual account that allows you to trade with virtual money until you find strategies to help you become a successful forex trader.
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