How Does Currency Trading Work in India?
Currency trading is one of the most lucrative options to earn money for individuals. But the ordinary person in India has always avoided it due to the misconception that it is only meant for the affluent.
However, this is far from the truth. Currency trading in India is more common than perceived and is typically conducted via derivatives such as futures contracts. The global currency market is the largest monetary market, with a value 3 times larger than all stock markets and futures markets combined. For skilled investors, it presents a lucrative opportunity to make profits.
In this blog, we will discuss how currency trading works in India. Read further to learn more.
What Is Currency Trading and Forex?
Currency trading is the buying and selling of currencies with the objective of making profits. It can also be referred to as forex trading. For instance, suppose the value of 1 USD stands at 80 INR today. If you expect the USD to appreciate against the INR, you purchase more USD and vice versa.
The forex market is a global, decentralised market which serves as a medium for currency exchange, and it has two levels of operations, which are listed below.
- Over-the-Counter (OTC): Companies and individual investors generally trade in this market. It enables anyone to trade currency via a broker and an online trading platform.
- Interbank: This is an exclusive section of the market that enables central banks to conduct large-scale trades among themselves.
The forex market facilitates buying, selling, and exchange of currencies at market rates, and it is the largest financial market. The forex spot market lacks a physical location, and it operates entirely electronically.
There are different types of forex markets in India, which are described below.
- Spot Market: Forex transactions in the spot market require swift payments at the current currency rate, a.k.a. ‘spot rate’. Also, it is not susceptible to forex market uncertainty.
- Futures Market: Future markets facilitate payment and distribution in the future at an agreed-upon exchange rate, a.k.a. ‘future rate’.
- Forward Market: They are fundamentally the same as future markets. The difference lies in the fact that parties can negotiate their terms in the forward market.
What Are the Basics of Currency Trading?
In this section, we will discuss the basics of forex trading in India. Currency is traded in pairs, and the nature of the trade is denoted by certain symbols. For instance, if you want to trade Indian Rupees against Euros, the trade would be represented by INR/EUR. Every trade is denoted by three unique letters and the direction of the trade.
Traders exchange currency pairings through a broker on foreign exchange markets. One buys or sells these currency pairs with the hope that their value will appreciate and result in profits. Derivatives are often used to speculate on the future prices of currencies.
The essential functions of forex trading are given below.
- Transfer: Settling payments by transferring currencies from one country to another is a primary function.
- Credit: Currency markets provide credit in matters of international trade. For instance, an importer can use forex credit for a foreign transaction and settle it later.
- Hedging: Currency markets provide the facility to hedge foreign exchange risks.
The following are some essential terminologies that you need to know to understand the basics of currency trading:
- Percentage in point(pip): Pip refers to the minor changes in the value of a currency pair. For instance, if USD was 80 INR yesterday and 80.0001 INR today, the pip of USD/INR is 0.0001.
- Bid & Ask Price: The buying and selling prices of a base currency are known as bid and ask prices, respectively.
- Spread: The difference between bid prices and ask prices of a certain currency is its spread.
- Leverage: Leverage enables traders to trade with a higher amount than they already have in hand. It refers to the borrowing of funds with a margin to trade currencies.
- Lots: Currencies are traded in lots of 1,000 units.
Legality of Forex Trading in India
As per regulations set by the Security & Exchanges Board of India (SEBI) and Reserve Bank of India (RBI), no Indian citizen is allowed to undertake forex trading unless they follow specific rules and trade only via authorised brokerages.
If you are a resident Indian citizen, you can use specific forex trading exchanges like the National Stock Exchange (NSE), Bombay Stock Exchange (BSE) and Metropolitan Stock Exchange (MSE). Furthermore, the base currency should be INR. This means only currency pairs benchmarked against INR are legally tradable.
Almost all currency trading takes place using currency derivatives, which means there is no physical delivery involved. Previously, the only pairs available for trading were EUR/INR, GBP/INR, USD/INR and JPY/INR. However, since December 10 2015 onwards, more cross-currency options have been introduced.
According to the Foreign Exchange Management Act (FEMA), 1999, a.k.a. the FEMA Act, an individual can face imprisonment or be liable to a fine for any illegal forex trading conducted within the Indian Territory. However, there are no rules that prohibit NRIs from forex trading in India.
How Currency Trading Works in India
In this section, we will discuss how to trade currencies in India. The steps to begin trading currency are given below.
Step 1: Create a Trading Account
You should carefully select a SEBI-authorised broker to create a forex trading account. There are a few factors you should consider when choosing a broker such as reputation, technology, ease of use, leverage provided, fees and commissions etc.
Step 2: Conduct Research
It is crucial to analyse the market to know when to buy and when to sell. One should conduct research with thorough due diligence.
Step 3: Test Your Skills
Before starting the actual trade, you can practise your skills with virtual money in a demo account. This allows you to get the hang of trading and rectify your mistakes.
Step 4: Make an Initial Investment
Start trading with a modest amount before you get accustomed to it. It is vital to maintain discipline and develop a trading plan for successful trading.
Participants of the Currency Trading Market
The major participants in the forex trade are listed below.
- Hedgers: Hedgers use the currency market to hedge against exchange rate fluctuations. They include importers, exporters, banks and corporations.
- Speculators: Their primary objective is to earn profits from the forex market.
- Arbitrageurs: They capitalise on price differences of the same currency derivative between different exchanges.
Various Currency Pairs in India
Currencies are always traded in pairs, which are classified as follows.
- Major Pairs: Highly traded pairs which comprise 80% of the total worldwide forex trade. For instance, EUR/USD, GBP/USD, USD/JPY, etc.
- Minor Pairs: Less frequently traded pairs such as EUR/GBP, GBP/JPY, etc. They usually feature significant currencies apart from USD.
- Regional Pairs: Pairs based on specific regions such as AUD/NZD.
- Exotic Pairs: Major currencies paired with currencies of smaller economies. For instance, USD/PLN, EUR/CZK, etc.
The following are the most popularly traded currencies in India.
- US Dollar (USD): The most traded currency in the world, which is also highly liquid.
- Euro (EUR): The second most traded currency, widely used in the Eurozone.
- Pound Sterling (GBP): An extremely high-value currency with great liquidity.
- Japanese Yen (JPY): Asia’s most widely traded currency, which reflects the strength of Japanese manufacturing exports.
- Swiss Franc (CHF): Due to a negative correlation with CAD, AUD and US government yields, CHF is seen as a safe haven in forex trading.
To conclude, the forex market is a unique market which allows all kinds of investors to trade. To successfully earn profits from currency trading, you must be skillful in predicting exchange rate movements. However, before you jump into forex trading, understand the risks of volatility and leverage involved in this market.
Frequently Asked Questions
Is currency trading profitable in India?
The forex market is extremely volatile. Hence, the chances of profiting from forex trade may seem slim. However, with sound knowledge and suitable skills, you can earn profits from forex trading.
How large is the forex market?
Forex markets are one of the largest financial markets all across the world. According to a 2019 survey, the global forex market has an average daily turnover of around 6.6 trillion USD.
Is forex trading a gamble?
However, it is considered a high-risk trading activity.
What are the major risks of currency trading?
The following are considered the biggest risks of currency trading:
Extreme fluctuations in currency prices.
Monetary losses due to scams involved with trading outside authorised exchanges.
Risks of taking a highly leveraged position.