Currency trading can be really exciting for a day trader. Every day, trillions (yes, that’s trillions with a t) of dollars of currency are exchanged between governments, banks, travelers, businesses, and speculators. With every trade and every blip in exchange rates, you have new opportunities to make money.
Currency is a bigger, more liquid market than the U.S. stock and bond markets combined. It’s often referred to as the forex market, short for foreign exchange. Foreign currency may be an attractive place to store some of your trading cash, and it can be a great asset to day trade.
Here’s another neat thing about the currency market: Some types of currency trades are tax free. These trades are usually longer-term, involving the currency itself, not day trades and not trades in the futures or forward market. But still — tax free! In other words, don’t get suckered by ads for currency trading firms that promise tax-free income until you read the fine print.
How currency trades
The exchange rate is the price of money. It tells you how many dollars it takes to buy yen, pounds, or euros. The price that people are willing to pay for a currency depends on the investment opportunities, business opportunities, and perceived safety in each nation.
If American businesses see great opportunities in Thailand, for example, they’ll have to trade their dollars for baht in order to pay rent, buy supplies, and hire workers there. This situation increases the demand for baht relative to the dollar and causes the baht to go up in price relative to the dollar.
Exchange rates are quoted on a bid-ask basis, just as bonds and stocks are. A quote may look like this:
USDJPY=X 81.3150 81.5250
This is the exchange rate for converting the U.S. dollar into Japanese yen. The bid price of 81.3150 is the amount of yen that a dealer would give you to sell a dollar and buy yen. The ask price of 81.5250 is the amount of yen the dealer would charge you to buy a dollar and sell yen. The difference is the dealer’s profit, and naturally, you’ll be charged a commission, too.
Note that with currency, you’re a buyer and a seller at the same time, which can increase the profit opportunities, but it can also increase your risk.
Day traders can trade currencies directly at current exchange rates, which is known as trading in the spot market. When you exchange money to go on vacation in a foreign land, you are exchanging on the spot, and you are allowed to do it as a trader or as an investor. Day traders can also use currency exchange traded funds or currency futures to profit from the changing prices of money.
Where currency trades
Spot currency — the real-time value of money — does not trade on an organized exchange. Instead, banks, brokerage firms, hedge funds, and currency dealers buy and sell amongst themselves all day, every day.
Day traders can open dedicated forex accounts through their brokers or currency dealers and then trade as they see opportunities during the day.
If you are interested in trading currencies, be sure to check out the fees involved. Some banks and brokerages are really set up to do forex trades for businesses and travelers, so the fees will be too high for you to have a decent profit potential.