What is Currency Trading?

Currency trading is the largest financial market on the planet. It is estimated that in excess of $2 trillion US Dollars (USD) is traded every day. Compare this to the New York Stock Exchange's daily transactions of approximately $50 billion USD, and one can see that the magnitude of the currency trading market exceeds all other equity markets in the world combined.

The practice of currency trading is also commonly referred to as foreign exchange, Forex, or FX for short. All currency has a value relative to other currencies around the world. Currency trading uses the purchase and sale of large quantities of currency to supplement the changes in currency value in order to earn a profit.

There are two main reasons why the relative value of a currency fluctuates. The first is because of a "real" market, which is based on supply and demand. For example, as outside investors or visitors wish to buy things within another country, they are forced to convert their domestic currency into the currency of the country in which they are buying. Similarly, as money leaves the country, people must sell their currency for the foreign currency they will need to spend or invest abroad. Exchanging currencies drives supply and demand, which causes currency value to increase or decrease.

The second force for currency fluctuation is speculation. When investors think a given currency will act strongly or weakly, they will buy or sell accordingly. This speculation can have drastic consequences on a national currency, and consequently on a country's economy. During the East Asia Crisis in 1997, for example, as nations in Asia began facing economic downturns, speculators used currency trading to realize enormous profits and, in many analysts' view, helped to exacerbate the problem.

Currency trading has many very real benefits over different types of equity trading like the stock exchange. The spreads for Forex are extremely low, meaning there is not a lot of distance between the currency asking price and the bid price; this usually results in very low costs to a currency trader. The volatility, or measurement of how much the price varies over time, of the currency market is extremely high, which means that a trader can generate enormous return on a given exchange. The ratio of volatility to spread is approximately 500:1 for the Forex market, as compared to 100:1 for even the most ideal of stocks. In other words, currency trading generally entails a market with fluctuating prices and traders who agree on price.

Until recently, the currency trading market was closed to small investors. Banking conglomerates made up of multiple business and large multinational companies were the main movers of this market place. In the past few years, however, new technologies have opened the doors to investors of all stripes: it is now possible for individuals to participate in the market over the Internet. Several websites exist that allow a person to create an account and trade currency from their own computer; some services also have brokers to give advice, answer questions, and help manage trading. It is difficult to miss the enormous benefit of this "new" market for the individual investor: higher returns with lower risk, given the same amount of market knowledge, have a very small downside.