Forex or foreign exchange trading refers to the practice of trading various currencies using a global, decentralized market. Hailed as world’s single largest liquid market, the average trading volume easily exceeds $5 trillion dollars per day. In order to make it in this cut-throat world of currency exchange, traders rely on a number of trading strategies. Some of them are well-suited even for absolute beginners, while others require extensive first-hand knowledge of the field. Almost all strategies can be grouped into two categories: speculating and hedging.
Hedging describes the process of trading currency pairs. Companies often sell their products and services in different countries around the world and usually get paid in currencies corresponding to the country where the sale has occurred. But currencies fluctuate, which may result in that sale being valued at a price lower than what was expected or even predicted. In order to avoid a potential loss in revenue due to fluctuating currencies, businesses and companies will often hedge or protect themselves by trading pairs of currencies.
Traders working with international financial markets will often hedge the exposure of their foreign currencies in order to generate as much revenue as possible from a specific investment. For example, mutual fund managers who are working with a specific currency will try to hedge that currency against fluctuations and secure what is called a “pure exposure”, or exposure that was not hampered by fluctuations. As a well-established trading strategy, hedging constitutes a substantial portion of daily turnover of currencies.
Speculating refers to a set of forex trading techniques used by the majority of investors. It is called speculating because investors wager whether a specific currency will move lower or higher when compared to a different currency and try to take advantage of the difference in pricing to generate a profit. Alongside individual investors, speculators can also be seen in commercial and investment banks, as well as hedge and pension funds.
Trading currency pairs allow traders to wager which one of those two currencies will rise and which will fall. Currency trading is mostly done using a selection of highly active and liquid pairs. Investors who wish to trade some of these pairs need to understand all the characteristics and underlying details of those two currencies, including the different factors that may lead to fluctuations between them.
Hedging and speculating are strategies that focus primarily on the relative value of two currencies in any given pair. Arbitrage trade is a type of strategy where you would buy a currency at a specific price and sell it for a different price, thereby generating a small profit due to the price difference. Unfortunately, opportunities for arbitrage trades are fairly rare in developed and efficient markets where there is a large number of investors. These opportunities appear and disappear rather quickly and finding them require closely monitoring the market for any developments and acting the moment they appear.
Carry trade is a type of currency trade where countries with significantly low-interest rates would sell their currency and invest the profits in a different country that owns a currency with high-interest rates. The only prerequisite for making a profit using this strategy is to have a stable relationship between those two currencies. Carry trade very popular technique for markets with low volatility and is generally used by large and sophisticated investors, including hedge funds.
These are just some of many different forex trading strategies available both for beginners and seasoned investors. Each of them represents a set of trade-specific analysis investors use to determine when they should buy or sell and which currencies. You can even develop your own trading strategy if you want, just make sure to test them out on paper trade before you commit to real capital.