Buying and Selling
Anyone can trade currency. Individual speculators, banks, financial institutions, governments, and corporations all are involved in the global currency market. Currency is traded 24 hours a day, 5 days a week (weekends are excluded), making it very easy to become involved in the market. Currency is also extremely liquid, meaning that it can quickly be bought or sold. There is always demand for money; if you want to sell it, you will undoubtedly find a buyer.
There is no one place where currencies are traded. Instead, it is comprised ofa global network of computers, banks, and corporations. This may come as a surprise to those familiar with other trading institutions such as the New York Stock Exchange. This informal style of trading is known as “over-the-counter” trading. Because of this, the foreign exchange (Forex, or FX) market remains largely unsupervised. However, disorderly trading is not left to resolve itself. On an individual basis, sharp spikes in currency are intervened upon by the central banks of the nations involved. In the United States, this duty belongs to the United States Treasury. For the most part, the Federal Reserve Bank of New York keeps up the Treasury’s regulatory activities. This includes the daily buying and selling of currencies in order to keep the US Dollar at a somewhat stable price. Overall, these actions are relatively small compared to the volume of trading that goes on worldwide. Changes that central banks usually enact are usually small and short-lived. In effect, the Federal Reserve Bank of New York merely acts as an indicator of where the Fed wants exchange rates to go.
Trading currency is much easier now than it used to be. The individual trader, or retail trader, previously had to set up different bank accounts, one for each currency he or she wished to interact with, and then transfer money between the accounts accordingly. Another option was participating in the Futures market, which we will talk about later. Now, an individual can trade currencies one of two ways: through a bank or through a broker. Either of these methods can be accessed online. Even though the retail trader has access to the market, they account for a very small percentage of traders. Only about $20 billion US is accounted for through individuals. This equates to about 2% of worldwide daily volume.
When trading currencies, there are two key prices you should be aware of: the bid and the ask price. The ask price is what the specific seller of the currency is asking for, while the bid price is what the buyer is willing to spend. The difference between the two prices is commonly referred to as the “spread.” Depending on how much money is being exchanged, the spread may be as low as 1 to 5 points (pips), or as high as 300. The more money involved, the smaller the spread. The lower number is always the bid price.
To look at this in a little more depth, I will provide an example. Let’s assume that the bid price of the JPY is 117.58 and its ask price is 117.63. This denomination would show up on paper as: 117.58/63. To buy 117.58 JPY, you would have to spend 1 USD, while if you sold 1 USD, you would receive 117.63 JPY.
The spread is also the basis for the fee brokers will extract from your trade. There are no commission fees in the Forex market, rather, prior to each trade, a small amount is skimmed off the top. In a spread of 5 pips as in the case above, the service fee would be 0.05 for each 1 unit traded. A transaction that entailed 100,000 units of JPY would cost 5,000 pips, or 50 JPY. To make a profit in any trade this fee must be overcome first.
When trading currency, essentially you are selling one nation’s money and simultaneously buying another’s. Obviously, the goal here is to make money, so when you trade for a currency, you are buying it with the hopes that it’s strength relative to the currency sold will increase. In other words, you are hoping that the currency you got rid of will go down in value and that the currency you obtained will go up. There are exceptions to this known as open trades. These trades are not conducted simultaneously, rather a currency is sold, but one is not bought (or vice versa). This makes sense when both parties involved have differing views on where the currency they are obtaining is headed. If you believe you will get a better rate by delaying the trade, then this may be a profitable decision. Ultimately, open trades are at the mercy of the market. An investor in an open trade stands to gain or lose depending on which way the market heads.