India has witnessed a boom in the number of financial traders with the advent of online trading. It has become easy, even for people living in small towns and cities to trade in various financial assets. Even though one gets to hear mostly about equity and commodity trading in India, forex trading is the biggest segment globally.
Types of currency markets
Just like other financial assets such as equity and commodity, currency is traded in the spot or cash market as well as the derivatives market. In India, currency is traded in the derivatives market as currency futures and options.
How are currencies traded?
Forex trading is not like equity or commodity trading. One can trade in the shares of a company or buy and sell the contracts of a commodity, but a single currency cannot be traded. One can only trade in a pair of currencies.
The biggest currency pairs that are traded are Euro against the US Dollar, Pound Sterling against the US Dollar and the US Dollar against the Yen. A majority of currency pairs traded in the world have the US Dollar on one side.
A few years ago, there were no regulations for currency trading in India and investors had to open a trading account with brokerages situated abroad. However, now it is possible to legally trade in currency pair futures with proper regulation in place.
Basics of currency pair
It is not possible to trade in currency pairs without knowing what is currency pair? A currency pair has two currencies with the value of one currency expressed in relation to the other. For instance, if EUR/USD is 1.09, it means one Euro is equal to 1.09 US Dollars. In a currency pair, the first currency is the base currency and the second currency is the quote currency. The value of a currency pair is always given in the quote currency. In the example given above, Euro is the base currency and the US Dollar is the quote currency.
Trading currency pairs
Both futures and options of currencies are traded on stock exchanges in India, but currency futures are more popular than options. The minimum lot size for the currency pairs is fixed at 1000 of the base currency. While trading in currency pairs, the profit or loss is not displayed in INR, as is the case with equities and commodities.
The profit and loss of currency trades are shown in the quote currency. The profit and loss of the trade is converted to INR at the end of the trading day at the reference rate provided by the Reserve Bank of India. The central bank releases the reference rate at 12.30 PM every day. For example, suppose you buy 1 lot of EUR/USD currency pair at 1.0010 and sell it at 1.0015. Now the profit in USD is (1.0015-1.0010)*1000*1 lot = $0.5. The profit will be converted into INR at the reference rate, (0.5*76.03) = Rs 38.015.
Margin for currency futures
Trading in currency futures requires margin money, just like other segments. All contracts traded have an initial margin of 2% and an extreme loss margin of 1%. The margin will be in INR, but the contracts will be traded in quote currency and the margin will be converted into the quote currency. Trades placed before 2 PM use the reference rate of the previous day, while the trades placed after 2 PM, use the reference rate of the trading day.
Things to remember while trading currency pairs
It is important to understand your risk profile before starting currency trading. The risk profile of every trader is different and he/she forms a trading pattern based on the profile.
The importance of the right information increases while trading currency pairs in India as the asset is not as popular as equity and so there is a dearth of information for small traders. Choose a credible broker to receive timely currency news.
Risk management is as important as returns in currency trades, Specify the entry and exit points of the trade beforehand. It will help you keep the losses low.
Trading in currency pairs is not the most popular segment in India, but it is rapidly gaining ground. With adequate research and the right trading strategy, it is possible to generate decent returns through currency trading.