The advertisements that appear online about people who are making fast money from forex trading are very tempting. However, you need to be cautious as there are dos and don’ts in forex trading. Bending the rules will not only put you on the wrong side of the law, but also put you at enormous risk of loss. So if you are interested in currency trading, here is how you should go about it:
Derivatives traded on the stock exchange
Based on the report of the RBI-SEBI (Securities and Exchange Board of India) standing technical committee on currency derivatives traded on the stock exchange, SEBI drew up in August 2008 a circular allowing recognized stock exchanges in India to launch currency derivatives. Subsequently, currency derivatives were launched by both the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
The currencies that the Indian Rupee (INR) can be exchanged for are the US Dollar (USD), Euro (EUR), British Pound (GBP) and Japanese Yen (JPY). Thus, the currency pairs on which derivative contracts are present now include USD / INR, EUR / INR, GBP / INR and JPY / INR. In addition, cross currency pairs, viz. EUR / USD, GBP / USD and USD / JPY were introduced in February 2018. So essentially, for now, anyone residing in India under the Foreign Exchange Management Act (FEMA), 1999 is authorized to trade only in these seven currency pairs through the national exchanges. Additional currency pairs, as they are introduced by the exchanges in the future, can also be traded.
As with any other derivative contract, traders should maintain sufficient margin to also initiate currency derivative transactions. This will be the SPAN (Standard Portfolio Analysis of Risk) margin plus the ELM (Extreme Loss Margin) margin as prescribed by the exchanges for futures and options. These are monthly contracts, and the expiration will be two days before the last business day of the month. But contracts expire at 12:30 p.m. on the expiration day, unlike equity and commodity derivatives, which expire at the end of the expiration day. All of these contracts are cash settled in INR – daily settlement will be on a T + 1 basis while final settlement will be on a T + 2 basis. The contract size will be 1,000 units for all currency pairs except JPY / INR, which has a contract size of 1 lakh units. The Final Settlement Price (FSP) will be the RBI Reference Rate on the expiration day.
While individuals can use the currency derivatives route for currency trading, businesses can also use it to hedge currency risk. This aside, individuals and businesses are authorized by the RBI to enter into forward contracts with banks for the purpose of hedging the currency risk with respect to transactions for which forex is permitted to be used.
Foreign currency trading
According to the Bank for International Settlements (BIS) latest triennial report, released in 2019, daily foreign exchange market turnover reached $ 6.6 trillion in April 2019. The size of the market guarantees extremely thin spreads . In addition, the global foreign exchange market is operational 24/7. The amount of leverage offered is also huge which makes this market attractive to traders.
Because Forex is a decentralized market, you might feel like your broker has connected you to the actual liquidity of the market. However, the rules of many countries allow brokers to operate two types of brokerage houses, commonly referred to as A-book and B-book. In the A-book model, brokers only earn spreads i.e. transaction fees and all transactions of their clients are passed on to the ultimate liquidity provider, which are usually large multinational banks. On the contrary, in the B-book model, the bid / ask spreads can be comparatively wider, and the counterparty is the broker itself. Simply put, the losses of clients are the gains of brokers. You may have noticed advertisements like 1000 times leverage, “welcome bonus” of a few hundred dollars, etc. Such offers will most likely fall under the B-book model.
Leverage of 500 and 1000 times is common in the foreign exchange market. As we know, leverage is a double-edged sword; such massive leverage can cause anyone to trade unnecessarily more, thus increasing the likelihood of losing money.
There are many Ponzi schemes, promising very high returns and referral benefits, which encourage people to recommend such programs to their friends and relatives. This can cause you serious problems.
The brokers also offer binary options, which are not like the stock or commodity options offered by Indian stock exchanges. As the name suggests, the result is all or nothing. By entering these contracts, you predict that a currency pair will reach a particular level within a particular time frame. If so, you earn money; otherwise, all the money you bet will be gone in a matter of minutes or hours. These options encourage gambling which can lead to big losses and as a result many regulators around the world have banned this product.
However, the point to note here is that even experienced financial market participants who understand the risks mentioned above should refrain from trading in the foreign exchange market as it is prohibited by Indian regulations.
Anyone residing in India is prohibited from trading in the foreign exchange market abroad, and the RBI has repeatedly warned banks against transactions made to finance such transactions. The RBI has clarified that anyone residing in India collecting and making / making payments directly / indirectly outside India for foreign exchange transactions through electronic / internet trading portals will be subject to prosecution for violation of the Foreign Exchange Management Act (FEMA), 1999, in addition to being responsible for violating Know Your Customer (KYC) / Anti Money Laundering (AML) standards regulations.
Although funding by wire transfer and credit card is difficult these days, many have looked for other ways to transfer money – through money transfer intermediaries like Skrill and Neteller or through a personal bank account. abroad. But be warned because, according to the RBI, indirect transfer outside India to foreign exchange transactions via electronic / internet trading portals is also prohibited.
Disturbingly, many are mistaken in thinking that a resident Indian can transfer up to $ 250,000 per year under the Liberalized Remission System (LRS), regardless of the purpose. This is not true, as the program prohibits remittances from India for margin or margin calls to foreign exchanges / foreign counterparties and remittances for foreign currency trading. Those who continue to trade, bypassing the rules, should keep in mind that they are not only in violation of the laws, but also run other risks.
While the brokers you deal with may be regulated by monetary authorities in other countries. it does not mean that you are allowed to trade. Since regulations prohibit Indian residents from trading on the foreign exchange market abroad, if you have any problems with disbursing funds, etc., you cannot turn to anyone to remedy your grievance. In the event of a dispute, you may need to go to the country whose monetary authority exercises supervisory control over this broker. Even if you manage to win such a dispute and obtain monetary benefits, you will be questioned as to the source and reasons for the same by the Indian authorities and unfortunately you are already in violation of FEMA law by negotiating on the. forex.
Trading of seven authorized currency pairs via exchange traded derivatives
Close monitoring of global macroeconomic indicators, a must
For better liquidity, INR pairs can be used to construct cross pairs
Don’t fall for high leverage, welcome bonus, benchmark benefits in foreign forex trading
A practical guide to navigating the currency market
Now that you know that you can trade certain currency pairs via the exchange traded derivatives route in India, how do you decide which to trade? Enter fundamental and technical analysis.
Whatever the financial asset, the technical analysis methods remain the same. Ultimately, these are charts and patterns, candlestick patterns and four key price points to work on – open, high, low and close.
However, when it comes to fundamental analysis, to make better decisions in currency trading, one needs to understand the global macroeconomic picture and closely monitor macroeconomic indicators. Tracking – global economic cycles, major central bank policies such as interest rate decisions and unconventional measures such as asset purchase programs, inflation and the inflation rate differential between countries, the external trade balance, external debt, foreign exchange reserves, decisions of global institutions such as the International Monetary Fund (IMF) and the World Bank, etc. – is imperative.
For example, the United States publishes non-farm payroll (NFP) data on the first Friday of every month. Whenever data is released, all currency pairs containing the USD will experience above-average volatility.
Data becomes more important, especially when the central bank uses employment figures as one of the important parts of the political decision-making process. Another example is the inverse relationship between INR and the price of crude oil. As India is heavily dependent on imported crude, a price increase is detrimental to INR and vice versa.
EUR / USD and USD / JPY are the most traded currency pairs in the world. However, the liquidity of these cross currency pairs is very low in domestic trading. That is, it is difficult for traders to capitalize on the outcome of price movements in cross currency pairs. But to solve this problem, traders can build these currency pairs using INR pairs, which have sufficient liquidity.
To create a net long position in EUR / USD (when you expect the EUR to strengthen against the USD more than any other currency), traders can go long in EUR / INR and short in USD / INR. . Buying EUR / INR means you are buying euros by selling rupees and shorting USD / INR means you are selling dollars and buying rupees. Here the rupee in both trades is canceled and you have a net long position in EUR / USD.
Likewise, one can create multiple currency pairs like USD / JPY, GBP / USD, EUR / GBP, EUR / JPY, GBP / JPY. The additional transaction fees are the cost you pay for better liquidity.
First and foremost, it should be understood that currencies may not be suitable for wealth creation, like stocks and fixed income investments. Currency is used to preserve wealth and is primarily used as a commodity.