Currencies are normally unique to any country. In the days of barter, goods were exchanged for goods. Hence there was no need for a currency. When currency was first invented it was in the form of gold, stones, and even cotton bales. The issue of currency is the sovereign right of any government and that is why each currency has a different value. The value of any currency is an index of its economic strength and its trade surplus. Normally, countries with large trade surpluses will have strong currencies
For a long time, there was no recognized market for trading in currencies or in currency futures. Forex trading in India was restricted to the rupee forward market that was largely an inter-bank market. Currency trading in India picked among small and medium-sized investors after the introduction of currency futures on the stock exchanges like NSE and the BSE. Globally, the currency trading volumes are in excess of $5 trillion but the Indian currency market is still quite small by global standards.
What are the hard currencies in the world?
The concept of hard currencies refers to currencies that can be freely traded around the world and that are backed by strong domestic economies.
For example, the currencies like the US Dollar, the Euro, the Pound, and the Japanese Yen are examples of hard currencies as they are widely accepted and also traded.
Does every country issue its own currency?
Yes, every country issues its own currency which is normally issued by the central bank of the country e.g. RBI in case of India, Federal Reserve in case of the US, and Bank of England in case of UK, etc.
The only exception is the Euro region which uses a common currency called the Euro. For example, big nations like Germany, France, Italy, Spain, and the Netherlands have all given up their own currencies and are now using the common currency Euro.
I can understand how equities trade; but how do currencies trade?
- In the case of equities and even in the case of commodities this is quite simple
- However, in the case of currency trading there are two currencies so how is the trading price decided
- Most of us have seen the US dollar exchange rate represented as Rs.67/$. In technical parlance, this is called a currency pair
- So in the currency markets in India, you effectively trade pairs. However, the currency market in India is still evolving
What is currency pairs and how are they traded?
- In a currency pair, there are 2 distinct pieces viz. the base currency and the quotation currency
- The base currency is always expressed as 1 unit
- These currency pairs form the basis for currency trading in India
- However, forex market trading hours on the currency futures exchange are limited while globally the currency market is a 24-hour market
Can we understand the base currency/quotation currency in greater detail?
To understand currency trading basics in India, you need to understand the quotation currency and base currency.
In the rupee/dollar trade, the USD is normally the base currency and the INR is the quotation currency. So when we write USD 1 / INR. = Rs.67, then the USD is the base currency, the INR is the quotation currency and Rs.67 is the value. The base currency is always expressed in 1 unit.
Does the US Dollar have to be the base currency in currency trading?
Not necessarily. Any currency can be the base currency.
For example, in Euro / Dollar trades, it is normally the Euro that is the base currency and the US dollar is the quotation currency. Similarly, when we write INR 1 / Yen = 1.95, then the INR becomes the base currency and the Japanese Yen becomes the quotation currency with a value of Yen 1.95.
How to do forex trading in India (for investors)?
- In India, the NSE and the BSE offer currency futures and also currency options
- Not surprisingly, the USD/INR pair is the most liquid contract but other contracts are also catching up
- Structurally, the currency futures and currency options operate on the same lines as the equity and commodity derivatives markets
- Traders who want to take a view on currency can trade currency futures
For example, if you expect the US dollar to strengthen versus the INR then you can buy USD/INR futures. Conversely, if you expect the INR to appreciate then you can sell USD/INR futures. Also, the margins on currency trading are much lower than equity or commodities trading.
How to do forex trading in India (for companies)?
- Currency futures can be used by companies that have currency risk
- Say you are an importer who has an amount of $5 million payable in dollars after 3 months
- You can hedge this risk by buying USD/INR pair
- You have a payable of $5 million in March 2018
- Your risk is that if the dollar appreciates from 67 to 70 then you end up paying higher in rupee terms. So you can hedge your risk by buying equivalent USD/INR futures
- If the dollar appreciates to Rs.70 then the loss on your import payable will be compensated by your profit on the currency futures position
That is how currency trading in India works.
Key takeaways from Currency Basics…
- You can hedge your currency risk or even trade using currency futures
- It is beneficial for both individual investors & companies.
- Currency futures are still in a nascent stage in India
- Currencies are typically traded in pairs in the currency futures market