A common type of derivative trading is FX trading. It is a mechanism for speculating on price movements in fast-moving markets like currencies, indices and treasuries.
It offers benefits like being able to buy, or go long, if you think the price will rise or go short (sell) if you think it will fall. You can also trade on margin, which means you do not invest the full value of the underlying instrument you are buying or selling.
You don’t buy or sell the actual underlying asset (a currency pair, an index, company stock). Instead, you buy or sell a quantity of units of a particular asset, based on whether you expect prices to rise or fall.
Price movements are measured in points. When it moves in your favor as you predicted, you profit in multiples of the quantity of trading instruments you bought or sold. Obviously you lose multiples when the price moves against your prediction. It is important to remember that you can lose much more than you have invested.
Margin and Leverage – what they are and how they work
Leveraging means that you do not need to invest the full value of the underlying instrument that you want to trade in. You only need to deposit a portion of that. This is known as margin trading or the margin requirement. It is a mechanism for increasing your exposure to the price movements in the underlying asset and multiplying your profits greatly. However, your losses are also multiplied significantly because they are based on the full value of the trading assets and not just on the value you invested. That means you could lose a great deal more capital than the amount you deposited.
Online trading providers quote two prices for an instrument – the price they are selling at and the prices they will buy at. The difference is called the spread. The buy price is always higher than the sell price and typically the current market price will be roughly in the middle. Tight spreads are good because they represent the amount the price must move before you start to make a profit, and the less of that the faster you profit.
Some types of trading assets attract finance charges, called the swap rate, for each day the position remains open, which reduces the value of the assets. These charges are based on current interest rates, which are variable over time.
A swap is simply buying and selling the same amount of a currency simultaneously, at a future exchange rate.