Currency Trading

Financial Dictionary -> Investing -> Currency Trading

Currency trading is simply the purchase and sale of currencies on the foreign exchange (Forex or FX). With a volume of over two trillion USD, this market is considered the largest around the globe.

Small investmentinvestors had limited access to currency trading until recently. Large multinational corporations and banking conglomerates were the major players on this market place. With the development of new technologies, different investors were allowed in.

Currency trading is also referred to as foreign exchange, with most people using FX or Forex as a shortcut. To understand currency exchange, it is important to note that every currency has a different value compared to others. Because of the constantly changing currency demands, these values shift from day to day. So, if a currency is bought low today and sold high tomorrow, the trader gains profit.

How Currency Trading Works

Currency trading always involves different currencies, for example, Euro and US dollars. Every currency has a fluctuating currency exchange rate. The latter determines the value of one currency when exchanged for another. The exchange rate changes due to several reasons including geopolitical events, inflation, industrial production, etc. These factors determine when to buy or sell certain currency in order to gain profit.

There are two major reasons for the fluctuation of relative currency values. First, outside investors and visitors of a country convert domestic currency to purchase goods and services in a foreign country. Second, there is speculation on the currency market. Investors buy or sell when they think that a foreign currency will become strong or weak. Such speculative trading can have drastic effects on national currencies and countries' economies. During the 1997 crisis in East Asia, economic downturns followed after speculators realized huge profits through currency trading.

Due to the fluctuating nature of currency exchange rates, the Forex trader may have the opportunity to make huge profits. However, the risk of potential loss is high as well. Let's say that a trader decides to buy Euros, believing that the currency value will go up against the US dollar. When the value of Euro increases, the trader sells the amount in that currency in exchange for dollars, making a profit. The exact opposite may happen if the value of Euro goes down instead.

Advantages

Any trader can participate in the buying and selling of currency at a time of his convenience. Due to the unlimited access to the market, the trader may carry out transactions whenever there is a chance to make profit.

No commissions, exchange, brokerage and government fees are involved in the trading process. The traders only get the difference between the buying and selling prices (which can be positive or negative depending on the exchange rates) without other costs involved.

Investors in currency exchange can leverage the invested amounts to make higher profits. Because the traded amount of money is controlled, the investor has the option of adding more anytime.

Unlike other types of trading, currency exchange has lighting speed liquidity. When a currency has been traded, the transaction takes place over a couple of seconds.

Disadvantages

Foreign exchange trading is not for everyone because this type of investment carries high risks of loss. Individuals with limited experience and persons who make hasty decisions are among the victims of high financial losses.

Another point to consider is the chance to run into an online Forex scam. It is important to carefully check the Forex trading offers before pouring money into them.