The foreign exchange market (Forex) which is also known as the currency trading market is an international speculative market where currencies of global economies are traded in pairs. In layman’s terms, it’s the purchasing and selling of currency money. The Market is valued between 4 to 6 billion, and it out values the stock market by a comfortable margin.
Simply travelling abroad requires forex transactions. The conversion of the Indian rupee to the currency of the other country to is founded on the forex rate of exchange between the 2 countries in question. This forex rate of course relies upon economic aspects such as supply, demand etc. The currency market is so popular mainly because of the highly liquid exchange rate which fluctuates continuously.
Illustration-The price of the dollar as against the rupee is steadily increasing. The dollar is trading at Rs 61. A person A feels that the price is going to further increase and reach Rs 64 or more in the next few months. Person A can enter into a long position by purchasing the USD-INR currency pair on the exchange. If the Price hit’s Rs 64, then a profit of Rs 3 per dollar is recorded. So in the single contract of 1000$, you can earn Rs.3000.
The currency market is also often called an over-the-counter (OTC) market, as it trades directly between 2 parties. Unlike shares or commodities trading, forex trading does not take place on nationally regulated stock exchanges. The said OTC market is divided into three different categories- spot, forward and futures forex markets. As currency trading involves selling one currency in order to buy another, it is quoted in pairs.
To understand the transactions, we must remember that the price of a forex pair is how much one unit of the “base” currency is worth with respect to the “quote” currency. The “base currency” is always written first. 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, USD/JPY is a currency pair that involves buying the United States Dollar and selling the Japanese Yen.
Further, currency pairs can be branched into the following categories:
·-Major pairs - Highly traded. There are approximately 7 currencies that make up 80% of global forex trading - EUR/USD, USD/JPY, GBP/USD and USD/CHF are the most prominent ones.
·-Minor pairs - Less frequently traded. Often, these feature major currencies are traded against each other instead of the United States 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.
Conventionally, currency or forex trades are made through a forex broker. However, with the advent in technology, there has been a rise in online trading methods. This new trend of trading through Contract for Difference (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) employs the advantages of forex price movements using derivatives. Unlike non-leveraged products, one doesn’t take the ownership of the asset, but rather takes a position on the idea whether “the market will rise or fall in value”. It is a process based on predicting outcomes of a given set of the factual matrix on the basis of available data.
While such innovative trading methods can help make a quick buck it can also severely magnify margin of losses. This is why currency trading using CFD derivative method is illegal In India.
It is an established fact that Indian citizens, as guided by the SEBI and regulated by RBI in order to minimize risk incumbent in it, cannot undertake forex trading on Indian soil through any digital or online forex trading platform under any circumstances. This prohibition is laid down in a RBI circular issued in 2013, which prohibits forex trading through electronic or internet trading portals. 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 had limited trading for Indian residents to only trade currency pairs which are bench-marked against INR (Indian Rupee).
Any trade transaction made by an Indian resident trading through a specified Indian Brokerage platform allowing access to Exchanges based in India such as the NSE, BSE, MCX-SX, and also providing access to currency derivatives, 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.
It is pertinent to remember that under the Foreign Exchange Management Act (FEMA) 1999, one can face imprisonment or be imposed with a fine for trading or transacting in contravention to the rules of the SEBI or RBI. However, a note can be taken of the fact that there is no prohibition for NRIs to do foreign exchange trading in India.