What Is Forex Trading and how to trade forex in India?

What Is Forex Trading? How is Forex Trading done in India?

Forex (FX), also known as foreign exchange or currency trading is a global market, decentralized in nature, where all the currencies of different economies are traded- sold and bought. The forex market is the largest and also, the most liquid market in the world. With an average daily trading volume amounting to $5 trillion, the global stock market doesn't even come close to this. Simply put, forex trading is the act of buying and selling currencies and if you've ever traveled overseas, you've made a forex transaction. For example, on your trip to France, you converted your rupees (INC) into euros and when you did this, the forex exchange rate between the two currencies, based upon the supply and demand at that point in time, determined the number of euros you get for your rupees. Also, the exchange rate is highly liquid and fluctuates continuously, understanding which requires lucrative skills and broad insights into the market-based trading system.

Table of content:

• What is Forex?

• What is Currency Trading?

• Why do we have Exchange Traded Currency Derivatives?

• Is Forex Trading In India Legal?

• Define “Brokers” for Forex Trading

• How does the Forex Trading function?

• Strategies for Forex Trading in India 

• Who is eligible to trade in Currency Futures markets in India?

• Frequently Asked Questions

What is Forex?

Just like stocks, you can buy or sell a currency based on what you think its value is or by simply strategizing where its value is headed. It is legally allowed to trade Forex within Indian Exchanges like BSE, NSE, MCX-SX. However, you can hit big or lose it all just as easily. If you think a currency will increase or decrease in value, you can buy or sell it accordingly. With a market of this high flexibility, finding a buyer when you're selling and vice versa is much easier compared to any other market space.

Forex trading occurs when the buying-selling of one currency for another takes place as a part of the same transaction and categorically at the same time. The two currencies involved in the transaction form a currency pair, where a representation of each one is executed by three letters - the first two letters representing the name of the country, and the third letter representing the name of the currency, for example, Indian Rupees: INR, United States Dollar: USD, Eastern Caribbean Dollar: ECD, Australian Dollar: AUD, Japanese Yen: JPY, etc. 

As mentioned earlier, the foreign exchange market is decentralized, highly liquid, and global and the participants in the foreign exchange market include central banks, commercial banks, brokers, etc. The foreign exchange departments of the major banks are linked on a 24-hour schedule on a global basis. The major commercial centers of the foreign exchange are in London, Amsterdam, Frankfurt, Milan, Paris, New York, Toronto, Bahrain, Tokyo, Hong Kong, and Singapore. The central banks (RBI for India) monitor the market movements and are obligated to intervene, if required, according to the government policies.

What is Currency Trading?

Currency trading, often referred to as foreign exchange or Forex, is the purchasing and selling of currencies done purely with the objective of making profits. It is also referred to as 'speculative Forex trading’. To conclude, ‘currency trading’ and ‘forex’ are synonymous in a general sense but the former is done with the intention of making a profit out of the transaction.

For Example, Suppose you want to take advantage of the growing price of a dollar. The dollar is trading at Rs 64, you feel that price is going to appreciate and is expected to reach at Rs 67 in a few months you can enter into a long position by buying USDINR contract on the exchange. If the price goes to Rs 67, you get a profit of Rs.3 per dollar. So in the single contract of 1000$, you can earn Rs.3000.

Why do we have Exchange Traded Currency Derivatives?

An Exchange-Traded Derivative is a financial contract which is listed and traded on a regulated exchange. Simply put, these are the types of derivatives that are traded in a regulated manner. Exchange-traded Currency Derivative derives its value from an underlying asset that is listed on a trading exchange. It is also guaranteed against any default through a clearinghouse making it a safer medium. Due to its presence on a trading exchange, ETDs differ from over-the-counter (OTC) derivatives in terms of its highly standardized nature, higher liquidity, and ability to be traded in the secondary market. Note should be taken of the fact that ETDs include futures contracts and also, options contracts, that is, one can use a currency future contract in the form of Exchange Traded Currency Derivative (ETDs) to exchange one currency for another at a future date at a price decided on the date of the purchase of the contract. In India, such derivative contracts are used to hedge against currencies of higher value like dollar, euro, pound, and yen. Mostly used by corporations with significant exposure to imports or exports, these contracts hedge against their exposure to a certain currency. 

Is Forex Trading In India Legal?

It is a settled fact that no Indian citizen, as guided by SEBI and regulated by RBI in order to minimize risk incumbent in it, can undertake forex trading inside the Indian Territory through any electronic or online forex trading platform under any circumstances. By virtue of RBIs circular issued in 2013, forex trading through electronic or internet trading portals has been prohibited. However, forex trading is held legal when one does it through specified foreign exchange trading platforms and the base currency is INR (Indian Rupees). Simply put, the Indian Government has limited trading for Indian residents to only trade currency pairs which are bench-marked against INR (Indian Rupee).

As an Indian resident, as long as you are trading through any specified Indian Brokerage allowing access to Exchanges based in India such as the NSE, BSE, MCX-SX and also provides access to currency derivatives, the transactions made for the trade is held entirely legal. Earlier, the only tradable instruments were EURINR, GBPINR, JPYINR, and USDINR. However, the Reserve Bank of India further, from 10th December 2015 onwards, allowed exchanges to offer cross-currency futures contracts and exchange-traded currency options in three more currency pairs namely, EUR-USD, GBP-USD, and USD-JPY. 

At this juncture, it should be duly noted that under the Foreign Exchange Management Act (FEMA), 1999 or FEMA Act, one can face imprisonment or be imposed with a fine for forex trading done illegally in India. However, a note can be taken of the fact that there is no prohibition for NRIs to do foreign exchange trading in India.

Define “Brokers” for Forex Trading

According to Investopedia, the brokers are those firms that provide traders with access to a global forum allowing them to buy and sell foreign currencies. Transactions happening in this market are always between a pair of two different currencies which implies that forex traders either buy or sell the particular pair they want to trade. A retail forex broker or currency trading brokers are professional terms synonymous with Forex Traders. However, maximum forex broker firms indulge themselves in only a very small portion of the volume of the overall foreign exchange market whereas retail currency traders use these brokers to margin access to the 24-hour currency market for purposes of speculative predictions. Larger firms such as investment banks also provide Forex broker services for institutional clients.

How does the Forex Trading function?

Unlike shares or commodities, forex trading does not take place as exchanges but between two parties in a direct manner, categorically, in an over-the-counter (OTC) market. The said OTC market is divided into three different types viz, spot, forward and futures forex markets. Forex trading involves selling one currency in order to buy another, which is why it is quoted in pairs. In simpler words, the price of a forex pair is how much one unit of the “base” currency is worth with respect to the “quote” currency. Each currency in the pair is listed as a three-letter code - formed of two letters that stand for the region and one that stands for the currency itself.

For example, GBP/USD is a currency pair that involves buying the Great British pound and selling the US dollar which explains the prefixes ‘P’ for Pound and ‘D’ for Dollar.

Further, currency pairs can be branched into the following categories:

• Major pairs - Highly traded. Count to Seven(07) currencies that make up 80% of global forex trading -  EUR/USD, USD/JPY, GBP/USD and USD/CHF

• Minor pairs - Less frequently traded. Often, these feature major currencies against each other instead of the US dollar -  EUR/GBP, EUR/CHF, GBP/JPY

• Exotics - A major currency against the one from a small or emerging economy - USD/PLN, GBP/MXN, EUR/CZK

• Regional pairs - Pairs classified by region - EUR/NOK, AUD/NZD, AUD/SGD.

There are plenty of ways in which a person can trade forex by simultaneously buying one currency while selling another in the same transaction. Traditionally and for a long time now, forex trade transactions have usually been made through a forex broker. But with the rising popularity of online trading one can easily employ the advantages of forex price movements using derivatives like CFD (leveraged products, which enables a trader both, individual or institutional, to open a position for merely a fraction of the full value of the trade) trading. Unlike non-leveraged products, one doesn’t take the ownership of the asset, but takes up a position on the proposition “whether the market will rise or fall in value”, a process more or less like merely predicting outcomes of a given set of the factual matrix on the basis of available data.

Although the leveraged products can boost the profits, they can also magnify losses if the market moves against you which is why CFD trading is illegal in India.

Strategies for Forex Trading in India 

Given its liquidity in terms of daily trading volume, losing money is easier than actually making it. Following are some of the strategies generally employed to the cause - 

1. Price Action Strategy - The price action strategy is the most commonly employed strategy for Forex trading. It completely depends on the bulls or bears of the price action in currency trading and is typically useful in all kinds of market conditions.

2. Trend Trading - In this type of strategy, the traders need to identify the movement (whether upward or downward) of the currency price on the basis of which they need to decide on their entry point. Online tools such as moving average, stochastic, relative strength indicators, etc, are also available to aid the traders for the analysis.

3. Counter Trend Trading - In this strategy, a trade is made against the current trend with pure hopes of making small gains and is dependent on the prediction that the trend will reverse.

4. Range Trading - In a range trading strategy, the trade is made in a specific range of currency prices and are needed to identify the favorable price conditions in which they can trade where the price levels are usually dependent on the demand and supply for the currencies.

5. Breakout Trading - In this type of trading, a trader enters into the market at that point when the market is emerging out of a previous trading range, i.e, a breakout. 

6. Position Trading - Position trading is used by the seasoned veteran traders mostly and involves analyzing the charts at the end of the day. One needs to have a strong grasp over the fundamentals of the market to master this strategy. 

7. Carry Trade - The focus in the carry trade strategy is on the interest rate differential of the two countries whose currency is being traded. This involves selling out that currency which has a low-interest rate and buying the one which has a higher interest rate and hence is considered a rather successful strategy if executed properly.

Who is eligible to trade in Currency Futures markets in India?

Any Indian, residing in the territory of the nation, or a company including banks and other financial institutions can participate in the futures market. However, Foreign Institutional Investors (FIIs) and Non-Resident Indians (NRIs) are prohibited from participating in the currency futures market.

Cross Currency Exchange 

As mentioned earlier, the Securities and Exchange Board of India (SEBI) has launched cross-currency futures. The options have now opened up in euro-dollar, pound-dollar, and dollar-yen (EUR-USD, GBP-USD, and USD-JPY). 

Indian Forex Market

The foreign exchange market came into existence in India by as late as 1978 when the banks were granted permission to undertake trading in currencies by the RBI. Indian foreign exchange market as it exists today is well structured and conducted in a regulated-fashion by the RBI. The dealers authorized by the RBI can engage in such transactions. The foreign exchange market in India is composed of the “Spot and Forward” market. The forward market is active for a maximum period of six months in the Indian territory. In recent years, the maturity profile of the forward market has elongated, the credit of which goes mainly to the RBI initiatives. The link between the forward premia and interest rate differential appears to work largely through the leads and lags and it can be observed that the forward markets are also influenced by importers and exporters through a grant of credit to overseas parties.

Time Zones 

Following chart can be referred to understand the time-zone division of the Foreign Exchange Market abbreviated as a Forex market:

Even though a 24-hour market offers a substantial advantage for many individual and institutional traders, it is not deprived of certain pitfalls. Discussing one of which is that to monitor a position for such long periods of time is highly painstaking and near impossible for any trader which implies that there will certainly be trading times when opportunities are missed. What can be even worse is the situation when a jump in market volatility leads the spot to move against a set position. For reducing such a risk, a trader has to be vigilant and categorically aware of when the market is most volatile, and decide what times are best for his trading pattern accordingly. One of the greatest characteristics, or rather advantage, of the foreign exchange market, is that it opens for 24 hours a day enabling the investors to trade during as well as after normal business hours or also after work. One can even do the deed by night! However, not all time-zones can be treated equally as there are times when price action is consistently volatile, and also when it is completely muted. It can be concluded as a major observation that major trading sessions in Forex are directly interconnected with market hours.

Frequently Asked Questions:

Is Forex trading profitable in India?

Being a market with high liquidity, the chances to earn a profit is as slim as suffering a loss not only in India but anywhere in the whole wide world. With the right skill set and command over the fundamentals, one needs to learn all the tricks of this trade.

Where can I trade forex in India?

You can legally trade forex within Indian Exchanges like BSE, NSE, MCX-SX.

Is Forex trading just gambling?

Gambling is where you essentially and categorically depend on pure luck! Going by this standard, Forex trading cannot be considered gambling. It is a high risk-based process, where a trader tries to earn a profit by predicting the movement of the market.

Which currency pairs can be traded in India?

As mentioned earlier, only the following currency pairs can be traded in India -

• Rupee-dollar

• Rupee-pound

• Rupee-yen 

• Rupee-euro

• Euro-dollar

• Pound-dollar

• Yen-dollar

What if I want to trade the FX markets with international brokers?

Trading the FX markets with international brokers is illegal.

What is punishment for forex trading in India?

Section 13 of the FEMA states that the punishments in the contravention of the Act can result in the penalties as well as imprisonment under the Act.