How to trade in currency markets

While using money to buy and sell comes naturally to us, the thought of buying and selling money (currency) itself seems alien. And yet there is a market where one can trade in currencies.

This is known as the foreign exchange or currency market and is the biggest among financial markets with close to $4 trillion of average daily trading volumes worldwide.

With the advent of retail foreign exchange platforms, individual retail speculative traders constitute a growing segment of this market.

In India, too volumes in currency derivatives trading have been rising sharply since it was opened on the exchanges in 2008.

Good diversifier

By including currency in their portfolio, investors can reduce the overall volatility to an extent and increase returns.

This is because currency has a negative correlation with other asset classes such as stocks, bonds and real estate. Foreign exchange markets are most liquid of all the financial markets. Most currency pairs generally move around 1 cent a day, representing a less than 1 per cent change in the value of the currency.

This makes the currency markets one of the least volatile financial markets around.

Currency prices are based on objective considerations of supply and demand and cannot be manipulated easily.

This is because the size of the market does not even allow larger players such as the central banks to move prices at will.

Volumes have also seen a rising trend in India. Combined volumes in currency futures have increased at a CAGR of 132 per cent from 2009 to 2011 in NSE-CDS and MCX-SX exchanges after it opened up for trading in 2008.

Depth has increased in all currency futures pairs as well. This means lower impact cost and provides a good opportunity for retail traders to benefit from this new emerging asset class.

Currency exchange such as MCX-SX provides low-cost platform for those who want to hedge their positions. But that doesn't mean that this market is only for exporters and importers.

With a very small initial margin required to start trading, this market is a must try for all. Retail investors should adopt an asset allocation approach and deploy 5 to 10 per cent of their portfolio into currency trading to start with.

We have access to euro, GBP and dollar pairs against the rupee. In 2011, dollar has given phenomenal returns of 18.8 per cent against the rupee, which is highest after gold returns.

Currency correlation with different asset classes is another factor which helps in increasing overall risk adjusted returns of portfolio. For example, gold (often called the anti-dollar) is negatively correlated with dollar (DX- Dollar index).

Currency futures do not require underlying exposure and therefore this can now be a part of portfolio of retail investors for enhancing overall returns.

High leverage is another highlight of this market and even small traders can start participating with relatively low investments.

Margin required in dollar-rupee pair is around Rs 1,600/lot and lot size is also low at $1,000/lot, thus allowing deeper penetration for retail segment.

Similarly, euro and GBP pair also has trade denomination of 1,000 lots. However, this is a double-edged sword and retail participants are advised to take professional help for trading in currency markets.

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