How To Trade Foreign Currency

Think of a Currency Pair Like A See Saw

How To Trade Foreign Currency‘ is a common question asked online and one I get asked all the time, so I thought why not answer that specific question.  In order to understand how to trade foreign currencies, it is important to know that a currency’s value is always relative to another currency, such as the GBP vs the USD giving the currency pair, the GBPUSD.  Once you have selected a currency pair, then you are ether buying it, selling it or doing nothing.  If you Buy the GBPUSD currency pair, then it is because you think the GBP will strengthen in value against the USD, over time.  Similarly, if you sell the GBPUSD it is because you think the GBP will weaken against the USD, or the USD will strengthen in value compared to the GBP, over time.  Once you understand this concept then there are several ways to trade Foreign Currency:

  • Firstly, one can hold foreign currency in a special bank account or investment account and then convert that into another foreign currency or you own country’s currency, at an appropriate moment in time, if you think that will be advantageous to you financially, over time.  One can analyse currency pairs on charts and try and determine when they may be at a turning point in their relative values.  So for example, if the EUR has been strengthening against the GBP for a while and you hold Euros, then when you think the EUR might start to weaken against the GBP, then you can exchange your Euros for Pounds Stirling. The same principle applies across all currency pairs.  When you undertake such a Foreign Exchange (Forex) transaction you will be charged a Commission by Banks and Foreign Exchange Merchants.  Some Bank and Investment Broker accounts offer more preferable rates.   Central Banks buy and sell or trade Foreign Currency this way in order to take advantage of currency strength and weakness around the world and to build reserves in strong currencies, in order to support their own currency in times of its weakness.  Central Banks can buy their own countries currency by selling some of their Foreign Currency Reserves and if doing so on a large scale, can support or strengthen their own country’s currency.
  • The next and most common method of how to trade foreign currency is to open a trading account with a Regulated Broker, usually in your own country’s base currency such as GBP in the UK or USD/CHF or JPY and buy and sell currency pairs at the Market price known as the Spot price.  Most brokers offer this service using a financial instrument called a Contract For Difference (CFD).  Professional and Retail traders use this method and often employ a certain amount of leverage in their account to do so. You pay a spread when you take a trade, which is the difference between the buy and sell price at any moment in time.  If you hold the trade overnight or over a weekend you will incur a charge called a SWAP, which is normally based upon the interest rate difference between the two currency’s countries with a bias in the favour of the Broker.
  • Another method is to Buy and Sell Futures contracts of currency pairs which usually last for 3 months but can be rolled over to the next 3 months and so on if the broker offers that facility.  With a Futures contract you will pay a larger Spread on opening the trade but do not pay the overnight SWAP charge and will also pay a charge if the Futures Contract ends and Rolls Over to the next 3 months whilst still in the trade.
  • Lastly, more sophisticated investors/traders sometimes use a financial instrument called an OPTION, where they buy or sell PUTs and CALLs dependant upon their view of particular currency pairs and how they might perform over time.  Options value decay over time, so you need to know what you are doing.

Most people will initially select the second method and learn how to trade foreign currency using that method, which is the method this website concentrates on.  I also use the first method for managing a relatively small amount of money with a view to getting the most advantageous foreign exchange rates over a period of time, in order to maximise my pot of Holiday spending money from year to year.  I use an online bank which provides much tighter spreads, and so keeps my Foreign Exchange costs down.  I am doing that though, using my ability to analyse Foreign Currency pair charts using Multiple Time Frame Analysis.

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