Ways to trade currencies

By: ispeculatornew
Date posted: 04.29.2009 (5:00 am) | Write a Comment  (1 Comment)

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forexForex, the FX market, these are terms to describe trading of exchange rates. There are many different ways to trade this market and if you count it by the amount of money involved, it is by far the most important asset class in the world, and it has important impacts in the world economies.

I thought I’d explain a few of the different ways that investors can trade in the FX markets.

1-Spot trades: This is clearly the easiest one, you can buy one currency and sell another one, as is the case with a stock or a bond.

A trade example is:

Buy 1,000,000USD, Sell 700,000 Euros

2-Forward trades: Same principle but when you buy a currency, you are actually promising to buy a currency at a certain point in the future. The main advantage is that you do not have to own foreign currencies in your account.

The same trade as the spot could be used except it would be “settling” in 3 months, July 25th 2009

3-Options: An option would be a leveraged play on currencies. An example would be:

Buy call EUR/USD

It is the same principle as a stock option really. You are either buying or selling what could be compared to a lottery ticket in the sense that you pay a premium, or a an amount for a “ticket”. If it goes in your direction, you can make a good amount of profit. However, if it does not, you will basically lose the value of your ticket, or the option premium.

The situation is the opposite of course if you are selling the ticket, or selling the option.

The quotation of an fx option looks a little more confusing, for example:

Buy 1 option on 10,000,000$USD – call EUR/Put USD strike 1,5 at a premium of 50,000$.

This can be done through listed options but institutions also do a great deal of trades on OTC options, that is options between two institutions on their own agreed terms.

4-Forex Swaps: These are deals that are generally for funding purposes. For example, if you have 10,000 Euros in your account and wish to keep those because you think the Euro will appreciate but are getting no interest on Euro balances, you can make a deal that will sell your Euros right now but that locks in a buy of Euros in the future. It is similar to buying a Spot and a Forward at the same time…!

These are a few of the ways that can be used to play the FX market, best of luck to all of you who are playing this market!

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1 Comment

  1. Comment by Francois — April 29, 2009 @ 7:38 am

    Interesting. I’m not expert and I’m trying to apply the concepts. I’m confused with the 2008 fiscal year of Caisse Depot Placement Quebec. Maybe you can help me to clarify.

    The cost of hedging the Caisse’s fund foreign exchange risk of its assets outside Canada had increased (due to the declining value of the Canadian dollar). 8.9 billion losses! Would it be that the Caisse make a deal on selling CAD$ that locks in a buy CAD$ in the future? I thought that currency hedging is used to minimize risk in exchange rates and currency values? Is that too risky for a pension fund?

    Also, can a small business doing import/export invest in a forex swap? What’s the minimum amount? would you advise to start with a forward trade instead?

    Thank you.

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