What is Forex trading?
Forex trading is one
of the most liquid trading activities available. It is simply buying and
selling of one currency by another currency at a price fixed by its buyers and
sellers. These currencies are each international, like INR and USD, and with a
fixed amount of one currency you can buy one unit of other currency. Say by
65.55 units of INR you can buy one Dollar. The next moment owing to demand
increase you need 65.60 units of INR to buy one Dollar. In this market,
participants try to predict the direction of price of either of this currency
in a pair. The volume of this trading is at par with the trading volume of
crude oil or gold futures. Forex deals with currency exchange or rather
currency pair transaction. This is a vast, vibrant market, spanning worldwide.
The major currency pairs in forex trading are GBP/USD, Euro/USD, USD/CAD,
USD/JPY etc.
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Among these, Euro/USD
is the most traded pair. The reason is obvious. Euro is the currency of a
consortium of European countries which include giants like Germany, France and
also debt-laden like Greece, Italy.
JPY is the currency of
Japan and is considered one of the most stable currencies. Recently Japan has
been going through a period of deflation and Japan government is also at pain
to keep its currency devalued especially with respect to USD. It does this to
protect its exports becoming costlier versus USD.
GBP is the Great
Britain Pound. Although traditionally one of the most stable currencies owing
to the excellent financial performance of UK, lately it has faltered. The
threat of financial business moving out of London and its surroundings owing to
Brexit, has devalued the currency. GBP is going through ups and downs, because
the negotiations of Brexit are opaque and nobody really knows the future of
businesses in the UK.
NZD or New Zealand
Dollar is also considered as a safe currency.
USD is considered the
benchmark of all the currencies. Here you may tend to ask as to why Yuan
(Renminbi), currency of China and extremely important, is not included in the
list of traded currencies?
It's because of fact that,
Yuan is not freely convertible currency. Its exchange rate is artificially
determined by China’s central bank. It's artificially devalued, especially vs
dollars, so as to keep its import prices low and attractive.
The forex market
operates for 24 hours for almost 5 and ½ days a week. It opens with the opening
of the Sydney market and ends with the closing of American Currency futures at
5.00 PM. This coves almost 24 hours in a day.
Forex trading is
totally done electronically over the counter and is largely unregulated. There
is no organization like SEBI to oversee the trading going on in Forex.
Where does Forex trading take place?
Forex trading is based
on the Interbank Market. It is an array of electronic platforms for currency
exchange, and not any physical exchange. Interbank market, as the name
suggests, is the market specialised for trading among the banks. Banks have
huge requirements of reserve cash for short duration, which spikes or ebbs with
demand and supply. Banks need this money mainly to comply with the loans sudden
withdrawal, or CRR ratio demand or any other regulatory requirements. The money
taken as a loan between different banks are normally for very short duration.
It can be for the overnight requirement, for a week or fourteen days at the
max. This money market is also termed as call money market. Rates of money
borrowed for overnight purposes are called overnight rates.
The borrowing/lending
is done via exchange of foreign currencies between banks of different countries
and different currencies. Reuters-Thompson, Bloomberg etc. provide the required
electronic platform for this foreign currency exchange and loans between
different banks. To keep this platform only for the banks, the minimum amount of currency that can be
exchanged are to the tune of millions of dollars. This keeps of any other
entity from using this exclusive Interbank platform.
Not only banks but
large financial corporations, insurances, mutual funds are also participants of
this interbank market.
The rate of interest
for lending in this market depends on ultra-short-term ongoing and perceived
rate of interest in future.
What we view as forex
rates in the money market is based on the interbank rates. However, the spread
or differences between ask and buy rates in the forex market is much larger
than the narrow spread found in interbank rates. What happens is that the
brokers and financial institutions charge a mark-up price on this basic
interbank rate and then place a bid in the forex market. This is the rate we
commonly see in the future of currency market. Thus the end bid prices in forex
market that we commonly view are derived from the interbank market.
Pips
The difference in the
ask and buy rates are in pips. For example, let's take the INR/USD pair. Say
the ask rate for selling is 70.6325 and buying rate is 70.6320. Pips are
defined as the movement of the third digit from decimal (of the price of
contract). You can get an idea of the liquidity by the difference of Pip and
the spread (difference between the buy and sell price) of a particular currency
pair.If the pip is say 5 paise, that
means that you can put a bid for that contract at onwards of multiples of 5
from the third digit after decimal.
What it essentially
transcribes to this: If you see a bid at say 70.6120, and want to bid lower
than that, you cannot bid at 70.6118, but at 5 paise lower than the 3rd
digit of decimal, which is at 70.6115.
When the pairs are
traded with high turnover like that of EUR/USD, the Pip difference comes in a
range of even 5 to 10 paisa. For example, if the buy price is 70.6125 for a
dollar by rupee (USDINR pair) and the
spread is of 10 paisa , then the ask price for selling that lot would be say
70.6135 i,e. a difference of 10 paisa.(note, lot size is 1000- so for a lot
buying price in the above example would be 70,612.50 while asking price for
selling that lot of 1000 USDINR would be 70,613.50). Note that because this is future trading,
actually the money you have to pay for taking a position in a lot of about 5%
of the actual price of the lot.
In case of thinly
traded counters, this difference of 5 to 10 paisa instead goes up to more than
one-hundred rupees and more (spread).
Is Forex trading legal internationally?
Forex trading is
largely unregulated, and largely illegal. European countries have large
participants and brokers for Forex trading, but the regulators there have also
warned about the dangers of trading in Forex. Japan allows forex trading but
with much reduced leverage allowed for taking positions. In USA , a handful of
forex brokers do exist. Check whether they are under CFTC and NFA. Forex
trading is legal in UK, Australia.
However, every country
is now trying to lower the leverage for forex trading and modifying its rules
so that Forex trading does not lead to adverse outflow of foreign exchange
owing to betting on the wrong side.
Why is Forex Trading so attractive? And so dangerous?
Forex trading is so
attractive because of the leverage provided by the brokers to entice customer. 50:1
margin for futures of forex tading with a minimum deposit in dollars is common.
100: 1, even 200:1 margin is provided by brokers of Fx. But note the lot size
of each pair .A single lot size can be 100,000. So adverse movement by even a
pip can be disastrous if moving in the opposite direction. And it can be
profitable in an awesome way if position is taken in the right direction. This
is the point where the regulators of each country frown upon. Awful amount of foreign
currency has to outflow from the country to meet the margin requirement.
If you are searching
for forex trading, you cannot but do it legally. In India, there are two types
of forex trading. One is based on base currency pair. Base currency means where
on one of the pair is the main domestic currency. In India, all the base pairs
have INR on one side. Like we have USDINR, JPYINR, EURINR. Here you have to pay
in rupees, that you have to pay for 1 USD (Dollar) or for 1 JPY(Yen) or
GBP(Pound of UK). This is available legally, under supervision of SEBI, RBI.
This is available in NSE and also MSE in India in currency segment.
Cross Currency Pair
Another important
currency pair that has been allowed recently by SEBI is cross currencty pair
e.g. GBPUSD, EURUSD and GBPUSD i.e. pound to dollar, euro to usd and yen to
usd. This is akin to big bang pairs in International Forex market, which are traded
heavily. So if you can trade legally in the most liquid Forex futures in India
itself, why would you want to trade in Forex via international brokers at a
higher cost?
Advantages that still exist and lure gullible desi traders
International Forex traders
have the advantage of timing and margin and lead regulatory oversight. It is
open virtually 24 hours, 5 days a week with very low number of holidays. The
margin provided by foreign forex brokers domiciled in India is also much more.
In India you can get a maximum leverage of 20:1 where 50:1 leverage is commonly
given in international Forex brokers.
The legal angle
Get it in bold word;
you cannot deal in any form of electronic Forex trading over internet or over
any electronic platform. You cannot remit any dollars under LRS (liberalized
remittance scheme) for any margin trading or derivatives trading outside India.
With LRS, you can invest in equities or in property, but not in margin trading,
the mainstay of Forex trading.
Do not get lured by
any Forex broker who says that you are doing a spot trade. You will have
absolutely no information of what type of trade is being done with your
dollars. You may find yourself fall foul of FEMA (Foreign Exchange Maintenance Act)
if your able your Forex broker to indulge in this Forex future trading
overseas.
The new cross Currency
pairs that have been approved by SEBI have an extended timing of 7.30 pm. This
would cover the European market conveniently. However this timing is inadequate
for USA markets.
To cover USA markets
confidently, a closing time akin to 11.30 pm as in commodities would have
served better.
FOREX trading has slim
chance of being approved in India. This is because RBI has to have adequate
dollar reserve. It cannot allow huge output of dollars, for dollar trading. For
business purpose, it has to allow corporations, funds and other bonafide entities
to trade currency, for hedging purpose. A large business entity who has taken a
large loan in dollars has to hedge his interest exposure. Otherwise he may have
to pay much more, should that currency appreciate suddenly against his base
currency.
So, if you want trade
in Forex, trade it through authorized brokers (under SEBI guidelines) in India.
New opportunities are arising (like the cross currency pair introduced
recently), be a little patient and do it legally in India itself. Whenever available,
trade in the cross currency pairs just like you would have done internationally.
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