Last updated on September 29, 2020
Currency trading is gaining popularity among Indian traders and is emerging as one of the popular trading platforms. Investors are becoming increasingly interested in trading in currencies. Currency trading, as the term itself suggests, is where the traders trade in a pair of currencies with the objective to earn profits from price fluctuations. Currency trading market is likely to become one of the fastest growing markets in India owing to the pace at which it is gaining popularity.
What is Currency trading?
Currency trading is the buying and selling of international currencies by a trader. Generally, it is the banks and financial institutions that are involved in the act of trading in currencies. However, individuals too can take up currency trading with the objective of benefiting from the variations in the exchange rate of the currencies. It is legal for individual traders to indulge themselves in currency trading.
The international currency market is the market that includes participants from all over the world. These different participants buy and sell different currencies. Majority of the currency market participants are banks, financial institutions, corporations, a central bank like the Reserve Bank of India, investment management firms, hedge funds, retail foreign exchange brokers, and the general investors.
When talking about the Indian currency market, it is essential to note that the Indian currency trading market is not cash settled. This means that currency trading in India is not settled physically. No actual delivery of the currency at the time of expiry takes place. Currency trading in India usually takes place between 9.00 am to 5.00 pm. In order to trade in international currencies, you need to open a forex trading account with a stock broker. A forex account allows you to trade in the live currency market.
When we mention currency trading, we are referring to currency futures. Currency futures in India are traded on platforms like the NSE, the BSE, and MCX-SX.
You also need to open a Demat account to trade in currencies. You can contact any of the best Indian stock brokers to open a Demat account in your name and can start with currency trading.
Every country has a unique currency, the value of which with respect to other currencies keeps on changing from time to time. The value of a country’s currency is dependent on various factors like the state of the country’s economy, the country’s foreign exchange reserves, the supply and demand of a currency, the policies of the country’s central bank, and other such factors.
Changes in the value of the currency affect both the importers and the exporters of the currency. Hence, currency futures were introduced in the year 2008 to protect the traders from the currency risks.
Currency futures in India were first introduced on the National Stock Exchange (NSE). They were later extended to other stock exchanges in India like the BSE, MCX-SX, and the United Stock Exchange. The currency options were introduced in the year 2010.
Just like a futures contract, a currency futures is a futures contract to exchange one currency for another at a fixed exchange rate on a specific future date. Currency futures are considered as financial derivatives because the value of the currency future is derived from an underlying currency exchange rate.
For a trader interested in trading in currencies, it is essential to make arrangements for the initial margin requirements. If the margin in the account falls below the minimum required margin, then a margin call is made to the investors. This means that the investor will now be required to deposit the amount of money that is necessary to arrive at the maintenance margin.
In a currency pair, there are two distinct pieces, i.e., the pair comprises the base currency and the quotation currency. The base currency in a currency pair is always expressed as a single unit. These currency pairs are the basis of currency trading in India. Globally the currency market is a 24 hours market, and hence the market trading hours for the futures are limited.
What are the Currency Options?
Just like an options contract, a currency option gives the trader the right but not an obligation to buy a particular currency at a specific rate in future. Currency option can be exercised only if the trader finds the price of the currency favourable in future. It is one of the two methods that is used by the traders for hedging apart from currency futures.
There are two types of currency options, including put option and call option. A put option gives the right but not an obligation to sell the currency at a specific price on a certain future date.
The call option gives the right to buy a currency at a specific rate. A currency call option works when you expect the Indian currency to weaken against the U.S. Dollar.
Risks involved in Currency Trading
Currency trading is both risky and complicated at the same time. It has several risks associated with it. Some of the risks associated with currency trading are as follows:
Credit Risk: Credit risks is primarily related to banks and financial institutions. It does not play any significant role in the case of individual traders, which means it majorly affects the banks and financial institutions participating in currency trading. Credit risk means that a voluntary or involuntary action of the counterparty has resulted in the non-repayment of the outstanding currency position held by the trader.
Interest Rate Risk: Interest rates have a significant impact on a country’s currency. This is because a difference in the value of two currencies can cause a dramatic change in the forex prices. Interest rate risk plays a potential risk to traders involved in currency trading.
Counterparty Risk: An investors’ asset provider is referred to as a counterparty. Counterparty risk is the risk that is caused by the default in the transactions by the dealers and the stock brokers.
Leverage Risk: As mentioned above, currency trading requires the trader to maintain a minimum needed margin, unlike in the case of equity and commodity trading. This offers the traders a benefit to leverage that allows them to have access to a large number of trades. A small fluctuation can result in levying of additional margin requirements that need to be maintained by the investor. Thus, market volatility, when paired with aggressive leverage, can prove to be highly risky for currency traders.
A currency trader needs to be aware of the various risks is possesses and hence should take decisions accordingly to avoid any losses in the future from his currency trades. Proper knowledge and understanding of the domestic as well as of the global economies is one of the essential prerequisites of currency trading.