Forex trading in India: An introduction for new traders

Forex trading in India: An introduction for new traders

The foreign exchange market is also referred to as the forex or FX market. In today’s age, it is powered by telecommunications technology and remains active 24 hours a day. It facilitates over-the-counter transactions in individual currencies between two participants where each individual currency is a market in itself, like the USD market or the GBP market. The foreign exchange market also sees a high volume of interbank transactions, which often define the currency values. Forex markets originated due to the requirements of traders to settle international trades. FX markets remain the oldest financial markets and have a large say in global financial liquidity.

How does it operate? 

Categories: Foreign exchange market has two distinct trading communities:

Interbank FX market has a network of banks and institutions who trade in currencies among themselves. These transactions are generally of very high volume, and make up for the bulk of the global forex market volume. The currency desks of different trading banks transact continuously, which keeps the currency exchange rate uniform. 

The retail forex market, on the other hand, has a large number of traders. The trading volume is, however, less than the interbank market as the value per transaction is low.

Let's get familiar with the different types of the forex market: 

The trading in the spot market happens at the place of transaction with immediate effect or within a short time. 

In the forward market, the transaction happens at a future date or range of dates, based on a customised contract between the parties to trade the currency at a pre-decided exchange rate. 

The futures FX market is also a contract to trade in the currency on a specified date and exchange value. But unlike forwards, a futures contract is standardised, legally enforceable and can be traded on an exchange.

Foreign currency swap also involves a forward contract at which future payment is made between two parties. However, before that, a currency swap takes place between the two parties at a spot rate. The swap happens with the same value of the two respective currencies exchanged between the two parties.

Purpose of the forex market

Hedging of currency risk is one of the two drivers behind the foreign exchange market. Through the FX market, a party to an international transaction can fix the currency value at which the transaction will be calculated. This insulates the party from a sudden devaluation in the foreign currency.

The volatility of the foreign exchange market offers good grounds for speculation among investors. While hedging may seem like an institutional decision to manage exchange rate risks, retail traders stand to make the most out of foreign exchange trading for speculative gains.

Operational details

There are two currencies involved in any forex trade, the first listed currency is called the base currency while the second one is called quote currency. If INR is the base currency while GBP is the quote, INR/GBP traded at 0.0097 means that one INR is equal to 0.0097 GBP. 

Traders will find currency pair classifications like major pairs (seven major currency pairs like EUR/USD, GBP/USD etc.), minor pairs like GBP/JPY, exotic pairs like GBP/MXN, and regional pairs like AUD/NZD.

The exchange rates fluctuate due to the demand-supply dynamics but are also affected by central banks as they control the currency supply. The country’s economic performance, current affairs and market sentiments also influence the domestic currency’s exchange rate.

Indian currency market

In India currency futures can be traded in popular exchanges like NSE, BSE and MCX. The trader here needs to open a forex trading account with the broker, and trading is done between 9 am and 5 pm. The trades do not involve any physical delivery and are cash-settled.

To make your first forex trade, you have to firstly open the currency trading account. You have to fulfil the broker’s KYC requirement for this. You will have to deposit a margin amount, which is the deposit amount that the broker holds while your forex trade remains open. You can start trading once your broker shares the access credentials to your trading account.

Risks involved

As mentioned above, various factors influence the exchange rate of a currency. What a central bank of a country decides is subject to the internal monetary policy of the country. If your trade involves that country’s currency, it will be subject to unexpected fluctuations. Therefore, currency trading is considered to be a high-risk playground.

Among the other key considerations, the main risk is an adverse change in the exchange rate. For speculators, this can lead to huge losses, if not chosen and monitored timely and regularly. There is also a credit risk regarding the non-payment of an outstanding currency position. Leverage risk is the risk of a loss beyond the margin amount. Aggressive use of this leverage amount can increase the amount of loss for the trader. Besides factors like fluctuation in the forward spread, mismatch in the forward contract amount and maturity gap in the transaction can add up the interest rate risk of the trader.

Choosing the right broker

If you are trading in FX through a broker, make sure that it is registered with the exchange and is of good repute. The leverage and margin options offered by the broker is also important. A 10:1 leverage in your margin account can allow you to take an FX position of Rs 1 lakh with a margin deposit of Rs 10,000. More aggressive leverage of, say, 100:1 may be offered by another broker. This can look good in case of a winning position, but also magnify losses in an adverse currency situation. The charges of the broker should matter to you. Find out if it is a fixed rate commission or the broker prefers to widen your spread (the difference between your bid and ask rates for the traded currency pair) and make money from it. The initial deposit required by the broker shouldn’t be too high, and the deposit and withdrawal processes should be convenient. And of course, the broker should offer you the currency pairs that you prefer to trade in.

Your trading style

There are different types of trading strategies popular among forex speculators, some like Daily Fibonacci Pivot Trade can take some time to grasp. Scalping is one of the simpler strategies where you day trade several times while carrying a position in another period. Scalpers keep a tab on important news releases like GDP, unemployment rate and inflation and try to make multiple small profits in a single day. On the other hand, in the positional trading strategy, you hold your longer position and profit from large market movements.

Whatever be your trading style, you should keep a check on your use of leverage and monitor the market movements regularly to avoid or minimize any forex losses.

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Disclaimer

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