currency trading

How Currency Trading Works?

What makes the world go round? Well, it’s certainly not “love” as you might have thought, but trillions of currencies

All that transactional volume ($5 trillion to be exact) has created a market that you’re probably eager to learn about -- that’s why you’re here

And you made the right choice because this article will explain all the basic stuff you need to know to get an idea about how currency trading works.

What is the currency market?


forex trading background

History can tell you that the exchange of goods in the past had taken different forms and with astounding creativity.

In grade school, your teacher had probably taught you about barter, which doesn’t resemble the embodiment of money represented by today’s fiat currency.

Because with barter, people exchanged things for other things, apples for oranges, or livestock for poultry — whichever the case may be.

Then there were gold coins, seashells, and eventually paper money.

These earlier versions of currencies provided a systematic way of trading as opposed to bartering: it assigns a widely accepted monetary equivalent to goods.

The fiat currency is a combination of the earlier forms of money, but with the addition of a digitized version — think of transferring money through the internet or purchasing online.

Also, each country has its own currency except for those that adopt the currency of another country, like Ecuador, Zimbabwe, British Virgin Islands, and some others that use the US dollar.

And since the value of currencies fluctuates relative to others thanks to the abolition of the Bretton Woods Agreement, traders have a global playing field for haggling over price differences, thereby creating a market.

barter exchange

Who participates in the currency market?


forex participants

Now, a market can't exist without participants who partake in the exchange of something. For example, the fish market’s participants are fishermen, vendors, and fish buyers.

In the currency market, the primary participants are the central banks of the world. The ones that follow are commercial banks, multinational corporations, fund managers, and retail traders.

How do the participants affect the currency market?


Central Banks 

Central banks can curtail or increase the production of their country's currencies by raising or lowering interest rates -- they can also just create money out of thin air by making an accounting entry to their balance sheet. 

Central banks like the Federal Reserve can also load up on currencies other than the US dollar for different purposes.  

But the most common rationale for the Fed to stock up on foreign currencies is to be able to meet obligations if something undesirable happens to the dollar.

Commercial Banks 

Commercial banks take part in the foreign-exchange market by speculating on the price movements of currencies to make a profit. 

There are assigned Forex traders in banks who take on significant positions in the global platform for currency trading.

Multinational corporations 

MNCs or companies that have global operations affect the flow of currencies through repatriation and international trade.

Repatriation

When MNC’s send the profits made overseas back to their home country, there is a conversion risk.

The bottom line of a corporation could report a lower figure due to fluctuations in currency rates.

As a countermeasure, companies may use a hedging tool by purchasing a currency forward, which is essentially a contract that guarantees a specific exchange rate for a future transaction.

International Trade

International trade affects currencies through imports and exports. Tesla, for example, imports auto parts from a company in China. What Tesla pays the Chinese company is not the dollar but the yuan.

Fund managers

Fund managers, specifically those who work for hedge funds, are also one of the players in the Forex market. 

They play their part by also speculating on the currency price movements for a profit.

Retail Traders

Lastly, the retail traders (or aspiring traders like you) make up for the smallest volume of trades from the group. 

When you start trading currencies, you somehow impact prices even for a minuscule capacity.


How it ties in to the value of currencies?


factors that affect currency value

Now, all those participants affect the daily ups and downs in price movement by influencing supply and demand.

Rates

For instance, if the Fed raises its rates, the US dollar can become more attractive, especially against the currency of a country with a lower interest rate.

You see when traders can get a better yield from the dollar, they can borrow in another currency, say the Euro, to purchase the dollar and reap its returns (also known as the carry trade).

Raising rates would also make people want to borrow less, which decreases the money supply. Conversely, money supply goes up if rates are lowered since people would be more encouraged to borrow.

Stocking up and Trading

And as mentioned earlier, when central banks pile up foreign exchange reserves, the effect is an increase in demand for a particular currency.

On the commercial banks and hedge fund side of things, prices can swing aimlessly in a minute if these big players execute large orders in reaction to news or economic data. 

While retail traders can react similarly, the likely impact may not be as pronounced as the banks and fund managers.

A more subtle influence on the demand and supply of currencies and without any particular attention to the underlying fundamentals of a country is through the mere act of exchanging currencies for international travel.

airport forex trading

Trading currencies to make money


Now, you understand who participates in Forex trading and how each of them affects the value of currencies.

But what's in it for you?

You came here because you wanted to learn how to make money in Forex.

So, how does that work?

As mentioned earlier, you are classified as a retail trader, and in a general sense, you are part of the market that trades on a lower scale.

And trading currencies is afforded to you by a Forex broker.

Forex brokers give you the platform so you can participate in trading currencies.

By opening an account with a broker, you get access to multiple financial products that you can trade.

You are also given access to a trading platform wherein you can place your trades.

How to do currency trading?


buying and selling a currency

Once you have an account in place, what you aim to do is take a position in particular currencies.

Since you're now aware that the value of one currency doesn't remain the same, especially when contrasted with another currency, your goal is to profit from by taking a side: BUY or SELL.

Now, as you gain more experience, you will become more in tune with BUYING and SELLING mechanics. 

But for the purpose of simplification, you BUY a currency when you expect it to appreciate in value over another, and you SELL it when you think it's poised to go down.

You then place these orders on your trading account that you opened with your broker. 

And, your job after that is to monitor how your trade goes.

If you predicted right, you gain a profit, and if you predicted wrong, you lose some of your account balance.

Continuous Learning


Everything may still be confusing to you at this point, so the best thing to do is to continue learning and become well-versed in the subject before you engage yourself in the activity. 

When you feel that you have adequate knowledge, don’t expose real money right away

Most experienced traders advise newbies to trade as much as they can with a demo account until profitability is consistent. 

A good three to four months of simulated trading would do a trader well in the long run.



13 thoughts on “How Currency Trading Works?

  1. Well! This is really a truthful insight to the rudiments that I feel all traders should know of before taking a dig at currency trading. Thank you so much for sharing all these here. Firstly, I wish to start trading forex since I know that it is very possible to make a lot of money doing that and I’m delighted you also shared the bad sides that I need to know and also, the need to trade and master it first on demo accounts before going big. Thanks

  2. Yeah I have really tried trading sometimes ago without even gone through training  I lost it all lol until I met someone that has been on training for like 3 months now told me I have to be on a demo account first before I start putting  on money alot of people do not want to go into the training they just wanna make money very fast and they dont know forex is not like that thanks alot for this post 

    1. Hi, Rose thanks for sharing your experience.  A lot of new traders are like that.  It’s the money-making potential that attracted them to forex (well, who wouldn’t be right?), and they never put into consideration the risks of trading this market.  It happens to almost everyone starting out.  And you’re right.  It’s all about learning as much as you can and practicing as much as you can before you lay real money on the line.

  3. I would like to be a part of currency trading in form of forex because it has been seen as a very good way that one can make some money. Would be very nice for me to learn a thing or two about it. I see that you have given a warning here too which I will have to take very serious note of as well. I will take your advice to make sure I keep learning everytime. Thanks for this.

  4. Its really amazing how money grew from one form to the other,  everything in this world now requires money and the exchange of currency between a party and the other. Forex is a good business to do, I’m not into it but I’ve read quite a bit about it and I can as much as its profitable, it can be so unpredictable. The best option is juts as you’ve said, is to read extensively about how it done. Thanks.

  5. This is a GREAT post about currency trading. Currency is definitely what makes the world go round, and I learned a lot from reading it. I’m pretty familiar with forex trading, which I’m glad you covered. I know many people are looking for this kind of information.

    I’m definitely bookmarking this site for future use!

  6. For a while now, I have wanted to learn all about currency trading but didn’t know anything really about it. I feel like I understand a bit about it now. Forex is most people’s preferred way of investing into currency trading. I want to know if there are other ways and what exactly is the possibility ratio of having success with it.

  7. I have traded stocks before, this seems like a great idea if you can learn how to trade currencies. I am somewhat worried about the ability of federal governments to be able to adjust rates which in turn would definitely impact the value of the currencies. Is there a governing agency that watches for stuff like this? Thank you for the information, looks like an interesting prospect!

  8. The tricky part of forex is the tendency to win it all and also to lose it all. There would be time where the stock is to one’s favor especially with lesser tradable amount when using the broker’s leverage. But then, the best way to keep staying on the profit side is to never stop learning. Every trader should keep on learning while self developing too. thanks

  9. A full information as to the blunt truth about the way currency trading actually works and t simple truths that any one should know of before making the decision to join in. Knowing what and how influences the market would help to know the various factors to consider before making any decisions when trading. Great one here

  10. Such an interesting article. A demo trading account would be my first move rather than trying to learn on the job! No thanks. Seems very risky.

    I read years back there were some big player European traders in Italy and they all decided to trade their stock at the same time which had a dramatic effect on the currency they chose.. I imagine since then, they’ve augmented the regulations governing such drastic trades at the same time.

    Thanks for the article, it was easy to read and understand.

    Best,

    Paul

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