Your money-making expert. Financial journalist, TV and radio personality.
Currency trading has never been easier. All you need is access to the internet, an appropriate brokerage account and you’re good to go!
But just how easy it is to make money trading currency? And what are the risks to look out for?
Keep on reading for all the details or click on a link below to head straight to a section…
Currency trading, or foreign exchange (forex) trading, refers to the act of buying and selling of fiat currency.
Believe it or not, the currency market is the largest and most liquid in the world. Unlike the stock market, currency markets are open 24 hours a day and only close at the weekend.
When it comes to trading currency the name of game is to buy currency and sell it for a higher price later down the line – assuming the price swings in your favour of course!
Now let’s quickly cover some jargon…
When trading currency, the currency you hold is known as the ‘base currency’. The currency you buy is known as the ‘quote currency.’
For example, say you have £1,000 and you want to exchange it for US dollars. In this scenario, pounds sterling (GBP) would be your base currency, while US dollars (USD) would be your ‘quote’ currency.
In this example, you would be relying on the dollar strengthening against the pound. The bigger the swing in your favour, the bigger your profit. Of course, if things go wrong and the opposite happens, you’ll be facing a loss.
Making money by trading currency sounds straightforward…
Exchanging one currency for another, waiting for its value to swing in your favour, and then exchanging it back to earn a juicy profit.
Yet in reality, making money trading currency can be tricky to say the least. That’s not to say it’s impossible. However, it’s important to bear in mind that in order to turn a profit when buying and selling foreign currency you need to beat other market participants. You see, currency trading, just like day trading, is essentially a zero-sum game. For you to win, another trader must lose out.
However, if you’re keen to give currency trading a go then here are three tips to give you the best chance of success…
Thanks to the explosion of mobile trading apps in recent years, there are now tens of investing apps that allow you to buy and sell foreign currency.
Yet not all apps are equal. For instance, some platforms will charge high fees, while others will try to rip you off with a poor exchange rate. Some platforms may simply be unreliable, deliver a poor customer experience, or limit you to a small set of currencies.
This is why selecting a reliable broker is a critical step towards becoming a successful currency trader.
Always do your research before picking a broker, and take the time to read online reviews from reputable sources. And if you’re looking to start with a low sum, pick a broker that will allow you to trade small amounts.
While the following aren’t necessarily endorsed by Money Magpie, here are some popular currency trading platforms worth exploring so you can make some initial comparisons:
When it comes to trading currency, it’s really important to understand and manage risk. One of the best ways to tackle risk is to embrace a disciplined approach and detach yourself from emotional impulses.
Whether you trade currency, stocks, or anything else for that matter, you’ll often find the most successful traders are the ones who exhibit patience, resilience, and the ability to accept both profits and losses gracefully. (For more on this, see how to recognise emotional biases.)
Make no bones about it, if you trade currency on a regular basis, you WILL suffer losses. There’s nothing wrong with this as it’s all part and parcel of investing. The problem comes if you try to chase your losses. Don’t do this. Instead, when investing or trading currency, always think of the bigger picture.
Interest rates, the economy, and politics. These are just some of external factors that can have a major impact on the value of a particular currency.
For example, when interest rates rise – or there’s speculation they may in future – this typically increases the value of a domestic currency. That’s because higher interest rates can attract overseas investment, boosting demand for the currency in question. This is why when Bank of England hikes interest rates, it often has a positive impact on the value of the pound, at least in the short term.
With regards to the economy, if a country experiences a shaky period this can have a negative impact on the value of that country’s currency. On the flipside, if a country’s economy is booming, then this can have a positive impact on the value of that country’s currency.
Of course, while currency traders can’t rely on a crystal ball to anticipate the impact of external factors on the value of currencies, it can be helpful to understand why these factors are so important.
Now we’ve explained what currency trading is, and how you can buy and sell currency to make money, let’s explore some of the risks….
As covered above, a big risk of currency trading is the risk of making a bad trade. Here’s an example…
Say you exchange £5,000 to US Dollars. You do this because you’ve expectation the pound will continue to weaken against the dollar over time, especially as you’ve little confidence in the UK economy (or its Government)!
However, soon after making your trade, the US Federal Reserve announces it is to hike interest rates due to the release of unexpectedly high inflation data. Meanwhile, in the very same week the Bank of England decides to lower interest rates in the UK, thanks to falling inflation data.
In this scenario, it’s likely the US Dollar would slide heavily against the pound.
While you may believe the price of the dollar will recover in future, this cannot be guaranteed – in much the same way that when a share price plummets, only a fool would think that it is ‘guaranteed’ to recover. It just isn’t the way markets work.
Of course, while you may be tempted to ‘wait out’ a bad trade, if you need access to your capital then you’d probably have no other choice than to cut your losses.
Of course, the above is a very straightforward example of a modest loss, but when it comes to currency trading, you shouldn’t disregard the risk of encountering huge losses, which can happen if a currency falls to near-zero – especially if you trade a currency known for its volatility.
To reduce the risk of large losses, you may prefer to stick with the larger, established currencies such as Euros, Dollars, Japanese Yen etc (though there are no guarantees, of course).
Another big risk of currency trading is borrowing money (leverage) in order to buy currency, and then seeing your trade go pear shaped.
While we’ve already explained how currency trading is mainly about buying currency with a broker, another way of trading currency is to use Contracts for Difference (CFDs). In short, a CFD is a financial contract where you pay the difference in the settlement price between open and closing trades. In other words, when trading currency with CFDs, you’re essentially agreeing to pay the future value of X currency on a set date.
Because of the way CFDs work, losses are essentially unlimited. What’s more, many CFDs providers will allow you to borrow money in order to trade. While this can increase your potential returns, using leverage can also send your potential losses into the stratosphere. This is why CFDs are very high-risk, and should be avoided altogether if you aren’t an experienced in investor (and even if you are an experienced investor, it’s worth knowing that many expert investors wouldn’t touch CFDs with a bargepole).
Instead, if you want to trade currency, then it’s probably best to start by buying and selling small amounts. It’s also a good idea to have a realistic understanding of your chances of success. Remember, never chase losses, and don’t trade more than you can afford to lose.
Are you keen to learn about investing? Why not sign up for our fortnightly MoneyMagpie Investing Newsletter. It’s free and you can unsubscribe at any time.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. Capital at risk.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.