Trading currencies has gradually become one of the most profitable ventures around, and it is something you can do if you take your time to learn about it. Although the primary way to make money is to trade the currencies directly, this is not the only option.
From forex options to CFDs, there are different options available to a trader. The best part is that you can do this with low trading costs and still reap all the benefits of trading currencies.
Trading currencies explained
Currencies are traded in pairs on a global marketplace known as the forex market. The forex market is one of the largest and most liquid financial markets in the world, which makes it a lucrative venture for many people. In the forex market, the most commonly traded currency pair is the EUR/USD and there are 6 other major currency pairs available.
When looking at a currency pair, the currency on the left is called the base currency, while the one on the right is regarded as the quote currency, and the exchange rate shows you how much of the quote currency you need to buy 1 unit of the base currency.
For instance, if the exchange rate for EUR/USD is 1.20 and you want to buy €1000, you will need $1,200 to do that.
So, when the exchange rate for a currency pair rises, it means that the value of the base currency has risen more than that of the quote currency and vice versa when the exchange rate falls. This is where the trading comes in.
Let’s assume that there is a currency pair called X/Y. If a trader believes that the value of X is going to rise over a certain period, the trader buys that currency. If the value of the currency rises according to their prediction, they can close their position and end the trade with a win. However, if the currency's value decreases within that time, the trader may end up in losses.
Trading currencies are regarded as over-the-counter transactions because traders speculate on the price of currency pairs without having to physically own any asset. Whatever you make will be based on the accuracy of your speculation.
Since making correct predictions is a key factor for success, traders try to increase their chances of success by learning about the market's sentiments and using technical analysis to predict the direction of the market.
Ways you can make money trading currencies
Here are the different ways you can make money aside from directly buying and selling currencies and even making passive income.
1. Using a Trading Plan Template
A trading plan refers to the methods or rules that guide your trading activities. Having one can determine how many trades you enter in a day, the requirements to be met before you can hold any position or enter a trade, and what you need to do to avoid any potential losses. Why do you need a trading plan template for trading currencies?
Experts over at HowToTrade say a trading plan template is essential for risk management.
A trading plan forms the basis of rational trading decisions by reducing the place of emotion in trades.
Although it is challenging to reduce the process of trading currencies to basic steps, having an outline in place helps you to stay disciplined and effectively manage the risks inherent in trading.
In addition, it keeps you consistent, especially for new traders who are trying to figure out which way is right for them.
Your trading template should:
- Reflection on your short-term, mid-term, and long-term goals. If you want to set it up as a side hustle or as a full-time job, your trading plan should indicate that and identify the milestones that you need to meet in order to achieve that.
- Contain entry and exit rules. The time you enter or exit a trade has an impact on the level of your wins and losses. It also helps with risk management.
- Show what your trading style and strategy are going to be. Are you going to be a swing trader or a day trader? Do you prefer holding overnight positions? Which timeframe are you going to work with? All these and more should be considered in your trading plan template.
2. Using leverage
In simple terms, leverage means using a small amount of money to control a larger amount. When trading currencies, using leverage requires you to borrow money, usually from your broker, in order to increase your position and, by extension, increase your gains.
The leverage you get can be up to 400 times your initial capital, but this amount is fixed and varies from one broker to the next because of the different rules and regulations.
However, the common leverage ratios you can expect from brokers are:
- 50:1: This means that if you have $1 in your trading account, you can place a trade of up to $50. For example, if you have $200 in your account, you can place a trade of $10,000.
- 100:1: This type of leverage means that for every $1 in your account, you can place a trade up to $100
- 200:1: The 200:1 leverage means that you can place a trade up to $200 for every $1 you have.
- 400:1: This is usually the highest leverage that can be given to any trader. For this, you can place a trade that’s 400 times more than the money you have in your account. For example, if you have $400, you can place a trade of up to $16,000.
Leverage makes trading exciting because you don’t have to use your own capital to hold such a large position. Still, at the same time, it opens your trade to volatility, especially if you don’t have a lot of experience using leverage.
Professionals tend to use less leverage because it protects their capital while giving them a chance to make consistent returns. Once you get the hang of it, you can always take higher leverage if you want to make the most out of your position, and risk management tools should be put in place in case of losses.
Although the leverage is there for your benefit, you don’t have to use it, and you can still make a lot of profit without it.
3. Trading with CFDs
CFD stands for Contract for Difference, and it is a technique used in trading stocks and for currencies as well. It is a type of derivative trading because traders make money based on the price movement of a currency pair without owning the asset themselves.
This is how it works. There are 2 parties in this: the buyer and the seller. If you believe that the price of currency A is going to be higher or lower than currency B at the time of closing, you can bet on that. When the contract closes, you will have to pay or receive the difference between the opening and closing price depending on whether or not your prediction was correct. Where the difference is positive, the CFD issuer has to pay you but if it is negative, you have to pay.
With CFD trading, you can make money regardless of the state of the market because all that matters is your speculation. In addition, brokers usually offer flexible lot sizes to traders using this method because of its volatile nature. Compared to other trading methods, CFD trading has lower brokerage fees.
4. Using Forex options
Forex options are another type of derivative trading that gives you the right to buy or sell a currency pair at a given price and date. Forex options are over-the-counter trades and the trader is under no obligation to fulfill the terms of the contract.
Traders use this method to trade currencies because it reduces the risk they face in the forex market and gives them a higher potential for profit. With this method, traders can get all the excitement and profits that the forex market is known for without having to buy any currency pair.
The downside is that the fees charged for trading forex options can be quite high, and once you enter an options contract, it cannot be re-traded or given to another trader.
There are 2 main ways you can trade forex options:
- Forex Call Option: You get a forex call option when you believe that the price of the base currency is going to rise compared to the quote currency
- Forex Put Option: You can buy a forex put option if you believe that the value of the quote currency is going to rise before the contract expires.
With this method, you also have to use technical indicators to make correct predictions.
Conclusion
Whenever you trade currencies, it is important to remember that it comes with their fair share of risks, and if you go in without taking your time to study the market conditions, you may not profit from it as much as you should.
Whether you are going to trade currencies directly or with the other methods discussed, combining it with technical and fundamental analysis is important to give you a better chance of success.
