With the introduction of exchange traded currency futures market, the currency trading in India is literally open to all with limited entry barriers. If you are a starter, how do you approach currency markets? Obviously, all the pairs and currencies may be sounding like Greek and Latin to you. What you must do is to understand the basic steps to follow to get your currency trading story right. Here is how.
Look at simple stories to trade
Pound weakening due to BREXIT is a simple trade. The rupee gaining due to the issue of sovereign bonds is a trigger for a simple trade on the rupee. A negative trade on the rupee when the FIIs are selling is also quite a simple trade to execute. The first step is to focus on such obviously simple trades. Don’t burden yourself with complex trades in the beginning. Be very clear on how much currency risk you are taking and whether you can afford to take on that risk. It has been observed that a large part of the success for some traders was a result of currency risk. That is not a very sustainable situation to have and could also backfire on you. One thing is clear, there’s money to be made trading currencies. But for new entrants to the market face a bewildering array of options, platforms and terminology. Keep it simple and keep it stupid in the beginning.
Find out who is trading and why they are trading
The average daily turnover in the forex markets is in excess of US$5.3 trillion and that is a lot of money and risk changing hands. Remember that not every buyer is a bull and not every seller is a bear. People have different reasons to buy and sell currencies. A lot of different people are trading, from large companies to part-time traders operating out of their bedrooms, something that only became possible with the proliferation of the internet. Corporations may be hedging, traders may be speculating, scalpers may be just rotating on small spreads and arbitrageurs may be scrubbing the spot-futures difference.
Get a hang of currency movements and the drivers
Unlike equities or even commodities and bonds, currencies don’t move violently on most days. But these currency levels do shift enough to help you make a neat profit or even make a loss. Most people already know that the values of currencies shift, that’s why exchange rates change. What drives these shifts is what you need to focus on and build into your business model. Changes in those rates are determined by multitude of traders buying currencies with other currencies and making judgements on what each is worth in relation to each other. Prices can change at great speed in response to news and global events. Traders look at key factors, including political and economic stability, currency intervention, monetary policy and major events such as natural disasters.
Understand the currency trading and settlement process
When trading currencies you normally trade in pairs. Of course, one can argue that the dollar index is an exception (DXY) but even that is a pair of the dollar with a basket of hard currencies. In India we have rupee pairs like USD-INR, GBP-INR, EUR-INR etc. We also have cross currency pairs and you can trade based on which direction you are betting on. The trader predicts how the exchange rate between the two currencies will change. So, if the trader believes that US dollars will strengthen against the Indian rupee then you can buy the USDINR futures contract or even the call option as the case may be. On the other hand if the expectation is that the dollar will weaken, then sell the USDINR pair or buy a put option.
Understand the risks inherent in currency trading
Your risk in currency trading is not just domestic but global and even extraneous factors. For example, if the dollar strengthens versus the Euro, that could boost the dollar index (DXY) and weaken the INR. That is entirely out of your control. In fact, many commentators have likened currency traders to professional gamblers, although that is a very rich idea bereft of an understanding at the ground level.