The largest financial market in the world is open around the clock. It has no central exchange. It is also the most competitively priced. Yet only a minority of private investors trade it, despite the fact that in the UK it can be accessed tax free by opening a financial spread betting account. This market is the foreign exchange market, also known as forex or FX.
Most people only trade currencies when they change money on holiday. But currency trading also represents a great alternative market to shares. This is because currencies are traded in pairs’: by using a currency spread bet or CFD (contract for difference), you are backing one currency against the other. Nobody talks about the forex market being up or down, because whenever one currency is losing’, another is winning.
You will usually see a currency trade quoted by your spread betting company as a pair of three-letter codes. Every currency traded in the market has a three letter code. For example, sterling is usually quoted as GBP, while the US dollar appears as USD. If you saw GBP/USD on your spread betting screen, the price next to it would be the number of US dollars that could be bought with one pound. If you then bought’ GBP/USD, you would be expecting to profit from a rise in the pound. If you sold’ it, you would be backing the dollar to strengthen against the pound (the number would go down as less dollars would be needed to buy a pound).
Spread betting and CFD trading also lets you profit from changes in currency prices by using margin: your spread betting company or CFD broker is lending you the bulk of the value of your trade by only requiring you to deposit a portion of it, your margin. This is particularly useful for currency trading, because many currencies only change incrementally against each other on a day-to-day basis.
Take the GBP/USD currency pair again: while the pound might strengthen against the dollar over a period of, say, a month, from 1.507 to 1.543, this is only a 36 point change. If you were trading using a financial spread betting account, at £2 per point for example, you would still only have made around £72. Luckily spread betting companies quote fractional changes to the currency rate, one decimal point further to the right. This means you might see the GBP/USD price move between 1.5442 and 1.5581 in a single day.
Now you have a daily trading range of 139 points, much more attractive from a spread betting point of view. Take that out to a month, and there could be a move of 300 points or more, up or down (depending on which side of the trade you are supporting).
As with other products made available by spread betting companies, currencies have spreads (the difference between the buy and sell price) and varying margin rates. The narrower spreads tend to be with the more liquid currencies, those that are bought and sold in big volumes globally, also known as the currency majors’. These include the US dollar, the world’s de facto reserve currency, as well as the euro, the Japanese yen, and the British pound.
Amongst the other popular currencies are the Canadian dollar and the Australian dollar, which are partly driven by the prices of the natural resources provided by both countries. When these are in demand, their associated currencies tend to go up as other countries are busy buying all that copper and oil. Similarly, they will tend to go down when commodities prices decline.
Beyond the eurozone, some other European currencies can see a lot of trading activity, like the Norwegian krona (another currency affected by the oil price, as Norway is a big oil and gas exporter) and the Swiss franc. The Swiss franc, usually seen as CHF’ on the trading screen, is often used as a safe haven’ currency: traders will buy it against another currency during times of market turbulence, when investors are becoming less comfortable with risk. This is because Switzerland as a country is seen as politically stable and fiscally prudent.
When spread betting on share prices, you are focusing on a company’s balance sheet, its results and the quality of its management. When spread betting currencies, you are focusing on countries’ economies, including how much money governments are borrowing and spending, and what their interest rates are. This is why many traders pay very close attention to statements made by central banks. In most major economies with freely tradable currencies, it is the central bank that sets interest rates. These can have a big influence over currency prices.
But apart from interest rates and borrowing, other factors can play a big part in the health of an economy. When governments announce unemployment and inflation figures, currencies can move suddenly. One of the more interesting currency trades over the last six months has been the euro. While the European Central Bank has kept euro interest rates steady, the near-bankruptcy of the Greek government, and the fears surrounding the economic health of a number of other eurozone economies, have led to heavy selling of the euro. At the same time, efforts by other eurozone countries to build a rescue package have prompted buying of the euro. This has made the euro an interesting currency for traders as it has moved up and down more frequently than it has historically tended to do.
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