Typically we exchange our currency for goods and services – we pay for our groceries, we pay the mortgage to keep our house and buy new clothes or a new car. However, typically when you exchange your currency for something like the light bill or a new pair of shoes, you’re not making an investment, and what you’re buying will have little value as a long term asset. Instead, if you invested in currency exchange on the foreign exchange market, you could make that exchange work for you, and exchange your currency, for even more valuable currencies.
What is the Currency Exchange?
Currency exchange operates on the foreign exchange market, which is similar to any market place, where anyone can come in and buy or sell goods. In the case of the foreign exchange market, the market place opens in Sydney every morning and moves around the world to New York so you can make a trade at any time of the day or night, from anywhere in the world. In the currency exchange market you are trading currencies where you may trade your British Pounds for US Dollars and back again.
You can then make trades and follow the markets because with a global market place comes fluctuating currencies which you can use to your advantage to profit from your investments if you buy and sell at the right time.
Benefits of the Currency Exchange
The currency exchange market is in a constant state of movement, and if you were to exchange 1 British Pound for 1.5 US Dollars, the next trader coming in a minute behind you may be able to make the exchange for 1 British Pound to 1.51 US Dollars. While this doesn’t seem like a significant shift, nor a huge profit, on the currency exchange you are usually dealing in much larger sums than one or one and a half dollars.
For example if you exchanged 100,000 British Pounds for 151,000 US Dollars you would have made a 1,000 US Dollar profit, than if you had completed the exchange at the previous 1.5 US Dollar mark. Plus, when currency exchange markets fluctuate, they usually do so by more than just one cent, so you have the potential to make an even greater profit.
At the same time, currencies can of course shift down and you could just as easily lose that 1,000 US Dollars – or more. That is why the volume of the profit isn’t the only benefit to currency exchange:
- Great opportunity. On the foreign exchange market you can trade in just about any currency you can think of, so there are always numerous opportunities out there to make a profitable trade. For example if the US Dollar looks as though it’s not going to be going up for some time, you can simply exchange your currency for a different one.
- Around the clock trading. As one foreign exchange market closes, another one opens so you are able to find the best opportunities for your investments from anywhere in the world, at any time of the day or night. This means you don’t have to miss out on any trade opportunities, and you can trade whenever you have the time.
- Spreads and broker advice. The trading spread on the currency exchange is the difference between the price you buy at (the ask price) and the price you sell at (the bid price) and is measured in pips. The spread is where a broker makes their money, as the spread helps compensate them for the risk they are taking hedging your investment. Therefore, if you can choose a broker with a low, or tight, spread, they will be taking the minimum amount from your profits.
How To Exchange Currency
Currency exchanges also happen whenever you need to get travel money for the country you are visiting. Also think about when you last bought something online – was the one store based in your country? Probably not, but you would have either selected your country and your currency at the checkout, your credit card company would have made the exchange for you, or you would have used an account such as PayPal which accepts a range of incoming and outgoing currencies.
Therefore, you can exchange your currency whenever you travel by visiting your bank and asking them to exchange an amount of your local currency, for the equivalent amount in the currency of the country you are travelling to. In this instance the fluctuations in the currencies around the world can affect your trade in the same way as if you were an investor in the foreign exchange market as the value of your dollar compared to the value of the currency in your destination country is constantly being adjusted.
In this sort of currency exchange it is your bank who is doing the buying and selling of the currency pairs. For example, if you are travelling to Europe from the US, you need to convert your US Dollars to Euros. Your bank will buy the amount of Euros you need, and sell them to you at the current exchange rate. If you wanted to buy 1,000 Euros from the bank, and the current exchange rate was 0.90 Euros to the US Dollar, those 1,000 Euros would cost you $1,111.11 US Dollars, which is the 1,000 Euros you want, divided by the 0.90 exchange rate.
Who Uses Currency Exchange
Whenever you travel or buy online you are exchanging currency, but the currency exchange market is also open for you to invest in. Typically currency trading was limited to big investors such as banks, governments and other organisations, but with new technology available through the internet, individuals can now participate in the foreign exchange market from anywhere in the world.
You have probably already made hundreds of foreign currency trades without thinking about it. Whenever you purchase an item online, or send money to family overseas, the transaction is carried out in the home currency of the countries involved. If it is a large transaction, such as one between multinational or central banks, a foreign currency loan may be required, which must be guaranteed and hedged to avoid any losses from the movements in exchange rates during the time it takes for the transaction to be completed.
Large multinational banks can also offer their high end customers foreign investment advisory services such as mergers or acquisitions. These investments could include foreign securities, property, companies or offshore enterprises and can be a very profitable way to take advantage of foreign currency exchange banking. These types of investments do require a high skills level, and access to large volumes of foreign currencies.
Many banks will also maintain a foreign exchange dealer who makes their money in the differences in price between what they buy a currency for and what they can sell it for. However you can start trading in foreign currencies simply by using reliable Forex trading software and your own investment funds. You’ll also need to research the foreign exchange markets to make profitable currency exchanges and with some practice you can be making successful trades. Plus, many Forex brokers and trading software platforms allow you to make investments during a trial period, where you can learn how the software and the markets work by making mock trades, but are never at any risk of losing your money.
How to Manage Currency Exchange Risks
To make successful currency exchanges you need to know how to manage the risks of your investments, and when it comes to the foreign exchange market that means understanding the factors which cause a shift in exchange rates.
Changes in the following three areas will affect the trades you make and the prices you get on the currency exchange market:
- The economy. The economic policy put out by government agencies, and the general economic conditions will affect which currency trades will be the most profitable. For example, the cost of money is regulated through changes in interest rates – when an economy is performing poorly interest rates will go down to stimulate spending and the value of that country’s currency will also drop. The currency market will also react negatively to a government budget deficit. If there is strong trade between countries there is a demand for that country’s currency to conduct those trades and it increases in value. If a country has a strong economy and healthy growth, with an increase in productivity, this will increase the value of the country’s currency.
- Politics. When there is political instability or uncertainty surrounding a new ruling party then the value of that country’s currency will usually go down. At the same time, if a country is in financial difficulty and a political faction with a financially responsible reputation is gaining a following then this can have a positive effect on currency. Don’t forget that events in one country can also impact on those in a neighbouring country.
- Psychology. The perception of a situation is just as powerful as the reality for example if there are unstable international events, there will be a ‘flight to quality’ as investors look for safer options and create a demand for the seemingly more stable currencies. Currency prices often reflect the impact of a particular event before it has actually happened, and when the expected event does happen, the currency performs in the opposite way than was expected before the event; this is where you will need to heed the trading adage of ‘Buy the rumour. Sell the fact’. The important economic factors to watch also change according to what is important at the time. For example the influencing factors in the past have been viewed as money supply, employment, trade balance figures or inflation. Many traders will also look for patterns in currency exchange rates – whether those patterns are there or not – and act on where those ‘patterns’ predict the market will go.