Currency Trading

by Stephan Smith on December 30, 2010

Are you familiar with currency trading? Do you know what it is? If you aren’t familiar, don’t worry because a great majority of people are in the same boat. Stock trading and bond trading are well known financial activities but for some reason currency trading isn’t. If you want to learn more about currency trading, continue to read this page because on it I will explain what it is.

What is Currency Trading?

Currency trading, also known as Forex trading (short for Foreign Exchange trading), is an activity that involves exchanging one currency for another currency on the Foreign Exchange Market. An individual who engages in such activities is known as a currency trader. There are two primary reasons an individual or business would want to participate in currency trading. One is to help facilitate the buying and selling of goods and services in countries using a different currency.

Since most producers won’t sell their goods and services in foreign currencies (some countries may prohibit the use of foreign currencies in their country), individuals and businesses will have to trade or exchange their native currency for the currency used by the country in question in order to buy from producers. If an individual or business wants to play the part of producer and sell goods and services to potential costumers in a foreign country, then that individual or business would have to accept the foreign currency used if one expects to generate revenue.

A great majority of consumers in foreign countries would only have their country’s currency available to them. So it would be in the best interest of the individual or business to accept their foreign currency and later trade them for its native currency.

The second reason an individual or business would want to participate in currency trading is due to the profit potential. A lot of money can be profited in the currency market if one knows what to do. Because currency value isn’t fixed but always changing, the value of any currency can fluctuate. Inflation is a common reason for currencies to become less valuable over time and disinflation and deflation are common reasons for currencies to become more valuable over time.

Inflation, disinflation and deflation are all results of how the money supply of an economy is manipulated by a central bank. Demand for currency also plays an important role in determining a currency’s value.

The concept of profiting from currency trading goes something like this. If you have one million United States dollars (USD) and you know that the currency will become less valuable in the near future, you can take your one million dollars and buy another currency. By doing so, you are essentially selling the United States dollar and buying another currency. Lets say you brought eight hundred thousand euros with your one million United States dollars (the fact that you were only able to purchase only eight hundred thousand euros with your one million United States dollars indicates that the euro is more valuable than the USD).

In this example, you exchanged one million United States dollars for eight hundred thousand euros. Imagine that six months passed and the United States dollar does indeed become significantly less valuable. Because you had used your one million United States dollars to buy eight hundred thousand euros six months ago and the USD became less valuable, you can buy more United States dollars than what you started with using your eight hundred thousand euros.

Why? Because the Unites States dollar is less value relative to the euro. Now lets say you want to convert all your euro holdings back to United States dollars. Instead of getting back your one million United States dollars, you are now able to get one million seven hundred thousand United States dollars because of the devaluation of the United States dollar. In this example, you’ve made seven hundred thousand US dollars in profit in six months.

Currency Trading Over the Counter

The primary way of trading currencies is to buy and sell currencies over the counter (known as OTC). Don’t know what that is? Allow me to expound.

Trading currencies over the counter (OTC) simply means a transaction is being executed between two parties. Person A is trading (buying and selling) currencies with person B; that is called an over the counter trade. This usually can be accomplished by going to a commercial bank, a third party currency exchange desk or using an online broker (one who will help facilitate the transaction).

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