Currency or Forex Trading: A Step-By- Step Guide for Beginners
Investment Trading primarily takes place in Equity, Commodity or Currency formats. The New SEBI Rules for trading that has come into effect from December 1st, 2020 no doubt promises to deliver greater transparency but at the same time Retail Traders might find difficulty trading as they have to maintain or pay their full margin upfront for trading in the cash market. This might lead small players to shift focus towards Forex or Currency Trading as it involves low costs with no brokerage or minimal brokerage fees in the form of spread i.e. the difference amount between two currencies. This blog post has a focal point of introducing Forex or Currency Trading fundamentals, Advantages & Disadvantages, Risks involved and Preparedness expected from the investors.
What is Forex or Currency Trading?
Forex stands for Foreign Exchange. The trading that takes place by exchanging currency of one country with the other is called Forex or Currency Trading. In Currency Trading we always transact with a Pair of Currencies. For Instance USD/INR is a notation used for representing US Dollars and Indian Rupees.
In the above notation of USD/INR
● USD stands for Base Currency
● INR stands for Quote Currency
If we tell USD/INR is trading at 73.56456 then it means 1 USD is equivalent to 73.56456 INR. Also here we have two concepts Going Long and Going Short. In the above example USD/INR pair if you think USD is going to increase against INR then you are going to buy the pair and is termed as Going Long. On the other way round if you think USD is going to decline in its value against INR then you would sell the pair and it is termed Going Short. Your profits depend on how well you can predict the raise or fall of the currency-pair.
Not All Forex Trading is Legal in India
In India Forex Trading is governed by SEBI under the Foriegn Exchange Management Act (FEMA). So, Trading in currencies other than INR as base currency or quote currency is illegal in India. INR paired with USD, EUR, GBP, and JPY are only allowed. No other currency trading is allowed without prior approval from the Government authorities. SEBI regulated Brokers who do not stick to the FEMA guidelines face severe penalties.
Types of Forex Trading
Broadly two types of Forex trading are in place they are:
1. Commercial Forex Trading
2. Retail Forex Trading
Commercial Forex Trading happens globally between the governments of different countries. Governments exchange currencies for various activities such as for payments on import of goods, to pay or issue overseas loans or to pay for buying goods or services overseas.
Retail Forex Trading is important from an individual trader’s perspective. Retail Trading has one single motto of making profits by speculating in the market. Two terms are important in this type of trading. 1) Call Buyer and 2) Put Buyer. You can understand these two terms by again revisiting USD/INR currency pairs. If USD gains value then Call Buyer is benefitted whereas if the INR gains value then the Put Buyer is benefitted.
Further the Forex Market is classified into three types Spot Market, Forward Market and Future Market.
● In simple words Spot Market is the one in which Real Currency is traded and it is the biggest Forex Trading platform. Currency is traded in terms of Lots.
● Forward Market is the one where Real Currency is not used. Instead contracts between parties are sold over-the-counters (OTC).
● The Future Forex Market also deals with contracts-buying and contracts-selling but a predetermined price for a future date is designated for actual execution.
Having understood the fundamental concepts of Forex or Currency Trading let us delve into advantages and disadvantages retail traders have to witness on deciding to trade in currencies.
Advantages: Forex or Currency Trading
1. Good for Beginners to Test the Water
Forex Trading needs minimal initial investments and offers greater flexibility. Hobbyists or Beginners in Trading can utilize this format of trading to understand the intricacies of the market before venturing into Stock Markets. Also entering into Forex trading is comparatively easier than other forms of trading.
2. Huge and Globally Recognized Market
Forex Trading is the world’s biggest market with on an average $4 Trillion USD transactions per day. Moreover the market operates round the clock with trading taking place in different continents at different time zones. Traders needn’t have to rely on any centralized trading exchange to be open as Trading happens over-the-counter (OTC) directly between the parties involved.
3. Low Transaction Costs is a Boon for Retail Traders
Not only the initial investment is low also the transaction costs are minimal. A small cost called PIP is incurred in these transactions. PIP in simple words stands for Point in Percentage. A minute difference between the two currency values is termed as PIP. Usually it will be 1/100 of a percentage.
4. Leverage Facility Amplifies Trading Benefits
Leverage is the process of using borrowed funds from the Brokers. Using Borrowed funds Retailers can improvise their market position. A definite advantage that stands out from the rest.
5. Ease of Liquidity
Unlike Stocks and Shares which cannot be liquidated instantly Currency Trading provides the flexibility of liquidity instantaneously. The high volume of trading and global presence proves beneficial for Currency Trading.
6. Currency Trading comes with advanced Technology Tools
Since Currency Trading is a new trend that is gaining popularity many tech-driven tools and platforms are available for traders to test the water before diving deep into the business.
Disadvantages of Currency Trading
Having seen the advantages Forex or Currency Trading offers. Many advantages it provides can act as a double-edged knife also. Here are important disadvantages experts identify:
1. Low on Transparency
Overall Forex Trading offers less transparency for traders due to its deregulated nature. But in India FEMA is in place to regulate currency trading which is a good sign. In addition relying on Regulated Brokers will mitigate the risk factors emerging due to lack of transparency.
2. Extreme Volatility Scares Traders
As no one single country has control over macroeconomics and geo-political developments across the globe predicting economical conditions is a hurricane task. Thus leading to volatility which frightens traders. According to experts, following the Strict Stop Loss approach is one solution to mitigate this risk.
1. Higher Risks due to Higher Leverage
Forex Markets offer higher leverage, Some Markets offer a leverage of 50:1, which is definitely a boon for traders with less capital but it can also lead to higher risks as losses get magnified. Experts opine by effective Capital Allocation this issue can be handled.
2. Need to be a Self-Learner
Unlike regular Stocks and Shares trading getting professional help to trade in the Currency Market is minimal. So traders are expected to learn trading processes from scratch on their own. This demands dedicated time from the traders which many usually don’t have.
3. Complexity involved in Price Determination
Analyzing World Economics and Politics is a complex process altogether which affects the prices of currencies. Arriving at reliable conclusions is difficult for even experienced traders and brokers.
Effective Strategies for Currency Trading
#1. Range Trading Strategy
Usually economies and countries whose currency remains stable and are less volatile can be traded with this strategy. The principle working here is traders have an understanding that the price range of such currencies usually remain constant within a range of values. Most important requirement for this strategy to work is identifying the Favorable Price Points. That means finding a juncture at which sellers stop selling and buyers start buying.
#2. Position Trading Strategy
This strategy does not work for Intraday trading or short-term trading. Basically Traders with long-term trading goals can use this strategy. Here Traders take into consideration long term macroeconomics trends of the economies. Also this strategy demands patience and diligence from traders.
#3. Breakout Trading Strategy
In this strategy a Trader enters the market at a point where the market is breaking out of the previous trading range. For instance say if the price breaks out of the previous trading range hoping it will go still higher. Other way round if the price drops below the previous support level and expecting it to go down further the trader will want to sell at that point. In between the prices can fluctuate between support and resistance levels several times before consolidating. It is during this consolidation time a trader enters or exits the market.
#4 Price Action Strategy
This the most popular and straightforward strategy employed in Currency Trading. The strategy is simple: If the market is Bullish (Up-Trend) or in Bull control continue buying and if it is Bearish Market (Down-Trend) continue selling.
#5 Trend Trading Strategy
This is a kind of Follow the herd kind of Strategy which is quite successful also. Here Traders take decisions based on the events like inflation, interest rate policies or govt policies. In this strategy the traders simply observe whether the price trend is positive or negative and based on it takes decisions.
#6 Counter-Trend Strategy
This Strategy works on the principle that at a particular point of time the trends-reverses. The counter-trend-trader analyses and decides after reaching a particular level down trend should reverse and similarly the vice versa should happen for upward trend also. Experts say this Strategy is difficult to master.
Can new SEBI Rules Prove Beneficial for Currency Trading?
SEBI new rule is aimed primarily to reduce excessive leverages given by Brokers to Traders. According to experts, the new rule will bring down the volume of trading but they also feel it provides longevity to the traders. As per new rule Traders are expected to have 25% of peak margin in their account. This in turn can move small traders to opt for Currency Trading as it requires minimal initial investments and also leverages are pretty high. According to Investopedia source leverages available with currency trading is in ratio 50:1. So, Currency Trading can prove to be an attractive option for small traders,hobbyists and beginners.
Zeva Trade Recommendations
Experts from Zeva Trade recommend USD/INR Option selling. In addition following advantages can be leveraged by going for Currency Trading.
1. Less volatility compared to our traditional Nifty and Bank Nifty.
2. Best suitable for salaried employees.
3. Small risk and consistent profit.
4. No need to see the screen (biggest advantage)
5. Your max loss possibly 5*% in the utter worst case.
6. Probability of winning more than 90%
7. Month-end your P&L must and should be in green.
8. After Dec 1 as per new SEBI rules most of the Client forceful to buy Option due to small capital. (Which is not good in the long run)
9. Very peaceful trade & a very good opportunity for jobholders.
Some disadvantages that traders would have to face are:
1. Not give much enjoyment as we are out of the market from 9.30 am to 3.30 pm (very difficult for Bank Nifty addicted traders)
2. Profit and loss do not come quickly.
3. Need patience like an investor.
