Master the Art of Forex Trading: Process, Strategies, Pros and Cons

Table of Contents

What is Forex Trading?

Forex trading stands for trading one currency for the other i.e. trading in foreign exchange. It is also known as currency trading or FX trading. Forex trading is the largest trading market in the world where several transactions are executed every single day.

Currencies are typically exchanged between countries, organisations or individuals to settle international trades across the globe. There is a form of forex trading done purely to benefit from arbitrage between currency price movements. This is commonly termed as forex trading.

Forex trading markets are the largest financial markets in the world since these are borderless trades done electronically. The daily volumes in forex markets cross USD 6 trillion. Unlike equity or commodity trading, forex trading does not have a designated exchange.

How does Forex Trading Work?

Forex markets are one of the largest trading markets in the world where various currencies are traded at all hours. Unlike other markets, there is no physical marketplace for forex trading. Traders all over the world trade currencies electronically. Forex markets work 24/7 on all days other than Sunday as global markets operate round the clock via computerized systems.

Major financial centres like London, New York, Singapore, Tokyo, Zurich, Hong Kong, Sydney etc witness large volumes of currency trades across different time zones. While other markets have a closing time, forex markets move from one time zone to another where markets open and close in different timezones, thus currency values fluctuate all the time.

Traders in forex markets are large financial institutions, large funds houses, investment banks, Ultra and High Net worth Individuals as well as retail investors. Government institutions, central banks and large commercial banks use forex markets to maintain their foreign currency reserves.

Other type of transaction in forex markets is to make profit from currency price movements. With the advent of technology it is easy for individual retail investors to participate in forex markets from any location in the world. Currency trades also involve large quantum of funds, hence attract seasoned investors.

Majority of forex trades are placed by institutions or banks for large clients, yet forex markets do attract retail and experienced individual investors from all over the world.

Understanding the Currency Pairs

Currencies are always traded in pairs. In a currency pair, one currency is the base currency and the other is termed as quote currency. The quote currency is traded against the value of the base currency, quote currency is bought or sold as per base currency value.

For example, in a USD/INR pair, USD is the base currency, you’d track how many rupees you would have to buy or sell for 1 USD. Currency traders profit by forecasting how much a currency will move with respect to the base currency. In a currency trade, you buy one currency and sell the other from the currency pair.

Different Groups of Currency Pairs

Globally, a trader can select from many currency pairs traded across forex markets. There are few currency pairs most popular in the forex world and a substantial forex trade is executed in these currencies.

These currency pairs feature the US Dollar as one of each currency pair as the US economy is world’s largest, and USD is the primary currencies that central banks use world over as reserves for investments, global trade transactions.

Internationally, many investment avenues and commodities are denominated in USD e.g. oil, gold. Daily volume in forex was nearly six billion US dollars for the USD currency in 2023, almost three times higher than the volume for Euro.

Euro is the second most traded currency in the world due to the economic importance of the region and volume of global reserves. JPY or Japanese Yen is the third most traded currency globally and third largest currency reserve.

Coming back to currency pairs, the following currency pairs offer maximum liquidity with extensive trading volumes. Due to demand and high trading volumes, these pairs witness movement in value and thus offer good momentum to profit from even minute fluctuations.

The most commonly trade and popular currency pairs are:

EUR/USD
USD/JPY
GBP/USD
USD/CHF
AUD/USD
USD/CAD
NZD/USD
EUR/JPY
GBP/JPY
EUR/GBP
AUD/JPY

In India, currency futures and options are traded on exchanges like BSE, NSE, and MSE for seven currency pairs.

USD-INR
EUR-INR
GBP-INR
JPY-INR
EUR-USD
GBP-USD
USD-JPY

Out of the above, there are three major currency pairs that are also widely traded globally. The maximum forex volumes in India come from USD-INR currency pair and the maximum futures and options contracts in India are in USD-INR. This currency pair offers large volumes and liquidity, hence most preferred to trade.

The reason for this being, INR movement is linked to oil prices, Fed rate policy announcements, macroeconomic factors like forex reserves, fiscal deficit, imports and exports data etc.

Understanding Spreads and Pips in Forex Trading

When you trade in forex, there are two prices quoted, Bid Price and Ask Price.

The ‘Ask Price’ is simply the price at which you can buy the base currency.

The ‘Bid Price’ is the price at which you can sell the base currency or the price the trader is ‘asking’ for to sell the currency.

The marginal difference between the Ask Price and the Bid Price is known as currency spread. It is also called bid/ask spread.

The spread is a fee built in the price of the currency that is charged for facilitating the trade transactions.

With price movement, the currency spread changes. This differential is measured through pips. Any change in the fourth decimal place of a currency pair is known as pips. It is the smallest unit of price movement in a currency pair. PIP means Points In Percentage. For most currency pairs, one pip is 0.0001

For example, if you are trading EUR/USD currency pair,

Assuming The Bid/Ask price is 1.0922/ 1.0924

Spread = 1.0924-1.0922 = 0.0002

Bid/Ask price is known as 2 pip spread.

The forex spreads can be wide or slim depending on currency pairs and market events. For example, a major currency pair will have a tight spread compared to an exotic currency pair.

Major pairs have large trading volumes, thus, the spread margin is slim whereas exotic pairs do not attract high volumes in comparison. The spread may change when there is high volatility in the market, or, events impacting the currencies.

How to Become a Forex Currency Trader

To trade in forex in India, you need to open a currency trading account with a SEBI registered broker. The process is simple.

Select a trading platform, check the currencies approved, margin requirements, and brokerage charges.
Complete the KYC by submitting required documents online.
Once the account is active, your account will receive approval from exchange to trade in currencies.

Basic Forex Trading Strategies

A forex trading strategy is a technique that a forex trader applies to decide when to buy or sell a currency pair at a point of time. As with any other type of trading strategies, forex trading strategies too can be based on technical analysis or fundamental analysis. There are few pointers to keep in mind before deciding on a particular trading strategy.

Currency Pair

A trader needs to decide on the currency pair they want to trade and gather information about how the currency pair has moved in the past, its volatility, volume etc.

Position Size

A trader must decide how big a position he is willing to take depending on his risk appetite and financial goals.

Entry & Exit Points

Traders must add rules for entry and exit in positions in the currency pair.

Time

It is important for traders to assess how much time they can devote to forex trading from their day, as forex trading is highly time sensitive.

There are categories of trading which are used in forex trading too

Scalping Strategy

Scalping strategy is based on utilising multiple price movements in a short period of time and making small profits with frequent trades, while limiting losses at the same time. Scalping traders often trade within minimal pip movements but this can also result in negative price movements and high losses when trading with large amounts or leverage.

Traders who can devote time during high volume trade windows can maximise opportunity for quick trades. Also, this strategy is suitable for highly liquid major currency pairs as traders can enter and exit the trades quickly.

Day Trading

Similar to equity markets, day trading in forex markets refers to trades done within a day. This is not as rapid as scalping, as trade depends on movement across a day and trade is not carried over to the next trading day. The trader monitors market movements and any major news that may impact currency movements on a particular day.

Swing Trading

Forex swing trading refers to a longer trading window where traders take positions not on the basis of short term movements in currencies, but on identifying swings in prices. This strategy allows trader time, as this does not require tracking markets every minute or hour of the day.

Position Trading

This strategy focuses on long term trends or movements in forex markets rather than short term fluctuations. Position traders hold positions for a very long term, which can be months or years, and monitor wider economic factors that impact forex markets.

Carry Trade

In a carry trade, a trader borrows one currency to buy another currency. The trader pays lower interest rate on borrowed currency and earns higher interest rate on purchased currency.

The difference in interest rates of two currencies is the profit margin that the trader earns. With this strategy, traders can make profits from both currency price and interest rate difference.

Let us look at some of the commonly used forex trading strategies based on variables like support and resistance.

Breakout Strategy

A breakout strategy looks for opportunity to enter a trade when the price ‘breaks out’ from its price range. This strategy aims to benefit from the momentum in a bullish or bearish price trend in a currency pair between support and resistance levels.

Forex breakout patterns can be identified at points of higher volumes and increased volatility. Chart patterns, technical indicators, consolidating markets, market related news or data can indicate breakouts.

Bounce Strategy

Bounce strategy is the opposite of breakout strategy where the price does not break the resistance level or support level. Instead, the price bounces back and traders enter the trade at support level expecting the bounce off opportunity.

Breakdown Strategy

In this strategy, the price moves below support level signifying further decline. The decline is supported by volume and duration is quick. Traders short sell when the price breaks support, and further downward movement and selling pressure is expected.

Overbought/Oversold

This strategy, instead of charts, uses a mathematical pattern known as oscillator. Oscillators study momentum by comparing price with trading range in a certain time period and chart values between 0 to 100. An RSI (Relative Strength Index) value above 70 or 80 signifies overbought conditions and a value below 20 indicates oversold conditions.

Forex Trading in India

In the 1990s, the Indian foreign exchange market saw far-reaching changes, coinciding with shifts in India's currency regime. The rupee exchange rate was pegged prior to this. It was converted to a partially floating rate in 1992 and it became a fully floating exchange rate in 1993.

In India, forex trading is legal, but the forex market functions under stringent regulations. It is important for traders to fully understand these rules before they begin trading.

Forex trading market in India operates with exchange of currency futures (a commitment to exchange currency at a specific price on a specific date) and currency options (similar to stock options where a trader has the right, but not the compulsion, to buy or sell a currency pair at an agreed price).

Forex trading in India is monitored by the SEBI. SEBI ensures that participants comply with the stipulations of the Foreign Exchange Management Act (FEMA) of 1999. RBI also oversees the regulatory aspect of forex transactions.

There are three types of forex markets in India

Spot Market

As the name suggests, transactions in the spot market are executed at the current currency rate known as spot rate. These transitions are swift and exposed to market’s volatility which can impact the price of the transactions.

Futures Market

In the futures market, transactions are executed at a future date at exchange rates agreed upon in advance, known as future rate. The agreements have defined terms which cannot be changed once agreement is entered. Futures markets attract traders who execute large quantum trades and looking for regular return on their forex holdings.

Forward Market

In forward markets, the terms are decided between parties for future trade, but these terms can be changed or negotiated, unlike futures market. Forward market offer flexibility to the involved parties and can be customised as per requirement.

Pros and Cons of Forex Trading

There are many advantages that forex markets offer to traders

Liquidity

Forex markets are the largest financial markets in the world with exchange worth billions taking place every day. There is no risk of illiquid instruments or not enough buyers or sellers in the market on any given day. Trades take place every minute with institutions, banks, and individual traders as participants.

Round-the-Clock Market

Due to varying time zones across different markets, forex markets operate 24 hours a day, five days a week, offering a wider trading window to participate in the markets.

Smaller Lot Size and Lower Costs

The lot size in currency trading is smaller and of lower value as compared to other Instruments.Traders, especially beginners, can start trading in currencies even with a very small corpus.

Also, currency trading is not liable for STT or CTT charges, hence the overall cost of trading comes down.

Leverage

Leverage is permitted in the Indian forex market which means that traders can trade larger positions with a small contribution from their side. Leverage in forex trading is much higher compared to other segments, therefore offers opportunity for higher profits.

Let us look at the cons of forex trading

High Risk

Forex trading carries high risk and traders stand the risk of losing their capital if they are not well versed with forex markets and do not hedge their risks. Leverage trading amplifies this risk.

Volatility

Forex markets are highly volatile, this can result in significant risks if traders do not understand market dynamics.

Forex markets are complex with multiple economic factors, global headwinds, interdependence on other economies etc. Traders need to continuously keep learning about markets, economic factors and stay updated on various developments.

Regulation

Forex markets are decentralized with no single regulatory jurisdiction which is not very transparent from a capital protection perspective.

FAQs

Do I need a broker for forex?

Yes, you need to open a forex trading account with a SEBI registered broker to trade in forex in India.

How much money do you need to start forex trading?

There is no minimum amount required to start forex trading in India. You need to open a forex trading account with a SEBI registered broker and start with an amount as low as Rs. 1000 - Rs. 2000. The quantum of trade depends on currency pairs and leverage obtained, if any.

Why should you invest in currencies?

Currency markets are one of the largest financial markets in India. You can take advantage of currency fluctuations due to various factors like economy, events, country specific news etc.

Currency trading is also an instrument to diversify your portfolio to shield against inflation and hedge the overall risk from different asset classes. However, currency trading requires continuous learning, staying updated about markets and events and risk management.

Which currency pairs can be traded in India?

Currency trading in India is permitted in 7 currency pairs- USD/INR, EUR/INR, JPY/INR, GBP/INR, EUR/USD, GBP/USD, and USD/JPY. NSE, BSE and Metropolitan Stock Exchange of India facilitate forex trading in India. Forex trading in India is regulated by SEBI and RBI.

Do I need to open a demat account for online currency trading?

No, it is not mandatory to open a demat account for forex trading in India. There is no physical exchange or delivery of securities involved in currency trading.

You need to open a trading account for forex with any SEBI registered broker. However, brokers offer demat and trading accounts at attractive terms and traders can utilise them for trading and investing in other segments.

How can I trade currency in India?

Currency trading is a complex yet globally popular trading instrument with high liquidity. To trade in currencies in India, you need to open a forex trading account with a SEBI registered broker.

Currency futures are traded on platforms offered by exchanges like the NSE, BSE, MCX-SX The currency trading hours are 9.00 am to 5.00 pm. In India you can trade currency futures and options.

How do I start forex trading online?

In India, you can trade forex on the NSE, BSE and Metropolitan Stock Exchange (MSE). You can trade currency pairs that include the Indian Rupee (INR). There are many brokers offering forex trading through apps or platforms.

How is the forex market regulated?

In India, the forex market is regulated jointly by SEBI and RBI.

Is Forex trading legal in India?

Forex trading is legal in India, but this market is highly regulated under SEBI and RBI supervision. You can only trade in seven currency pairs with the INR as the base or the quote currency. You also need to open a forex trading account with a SEBI-registered broker to trade in forex.

What is the lot size in forex trading?

The total amount of underlying assets per derivative contract is called lot size. For example, forex lot size refers to the total amount of the base currency of a futures or options contract. In India, currency pairs are traded in a lot size of 1000 of the base currency.

How to learn forex trading?

Forex trading requires knowledge and continuous learning on traders’ part. You can open a demo account with brokers and place dummy trades in a live trade environment without placing any real funds. This builds a traders confidence and helps practice trading strategies and acumen.

What is leverage in forex trading?

Leverage refers to a facility where you place a small amount to trade and your broker offers you a multiple of that amount as leverage to trade. Broker charges an interest on the funding for the time period it is utilised for. Leverage allows traders to place larger trades even with a small capital and potential to earn higher profits but it multiplies the risk as well.

What is the difference between trading currency futures & spot FX trading?

A currency future is a futures contract involving an exchange of one currency for another at a future date and at a fixed price. A spot FX contract entails the delivery of the underlying currencies occurring in the present as per the contract settlement date.