Currency trading is a complex subject for some people and has inhibited their willingness to enter the market.
I will dissect the mystery of currency trading with this article. If you’ve never traded currencies before, or just want to get started, you’ve come to the right place.
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A little background
The currency market is the largest in the world with approximately $ 6.6 trillion traded daily. Currency markets are a consequence of world trade. Take Emeka as an example, he wants to export cocoa to Holland, he will earn dollars from this transaction, Emeka then wants to buy rice from Japan and import it into Nigeria. This transaction involves many currency risks, in particular;
- When he sells his cocoa, the dollar may have gone down
- When he wants to buy rice in yen, maybe the yen has gone up
With the currency markets, he can buy a futures derivative that can lock in an exchange rate for rice and cocoa transactions. The thing to note is that currency markets were not created for speculation but for trade facilitation.
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The Market, the Lot, the Quotation, the Spread and the Pair
Trade in the currency market moves from market to market. Thus, the market will open in Asia, then to Europe, then the Americas, and again to Asia, closing Friday evening to reopen Sunday evening. Thus, buyers looking for the yen will see more yen volume as the Asian markets are opened up.
Currencies are also purchased in lot sizes, declared as Micro, Mini and Standard A lot. If you buy US dollars, the standard lot size will be $ 100,000, Mini will be $ 10,000, while micro is $ 1,000.
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Currencies are quoted in pairs. This means that you can’t just buy US dollars, like you would buy Tesla shares, for example. You need to quote to sell one currency and simultaneously buy another currency. For example, the base currency (the currency you want to buy) is quoted first, and the currency you quote to sell to get that base currency is called the last quote currency. So if Emaka wants to buy US $ 1,000 and sell yen, he will quote a mic by USDJPY.
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Currencies are also quoted up to the fourth decimal place. The lowest common factor in any currency pair is the Seed, if a currency increases, this increase is reflected in pip or the last digit of a fourth decimal place. The difference in the pips of the pairs is the spread. A large spread means few buyers and sellers, while a smaller spread means a lot of bids and therefore offers less room for arbitrage.
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It’s just trading, no deliveries
The traders are not like Emeka who wants to receive rice, the traders neither export nor import anything; thus, when trading, they do not expect to hold these positions or receive the contract currencies, rather they take a position or bet on the direction of that currency with the intention of spreading.
When traders buy US dollars, for example, they are betting that the US economy will grow, meaning more investors will want to buy US assets and ask for more US dollars to fund their purchase. Thus, traders are looking to switch from a less demanded currency to a demanded currency.
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Another example is a company that trades cross-border, for example BMW sells cars in the United States in USD but remits these funds to Germany in euros. BMW will offer to sell US dollars and buy euros on the US forex markets. So, BMW will quote EURUSD 1.21110 / 1.21115 to a broker, which means that it wants to buy euros and sell US dollars with a spread of 5 pips. (1.21110 minus 1.21115).
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Now imagine that many European companies export to the United States and need euros, they will continue to sell US dollars and buy euros. This will make the US dollar weaker and less in demand. In this scenario, a profitable foreign exchange transaction will be to take a position ahead and sell US today and buy Euros ahead, then reverse the sale by selling Euros to “BMW” today.
There are many ways for traders to determine currency movements, using technical analysis, but that’s another topic. It’s just the basics.
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