Currency trading is the act of exchanging one type of money for another. This typically takes place on the foreign exchange market (forex), which is a decentralized worldwide marketplace. Forex currency trading provides a number of benefits, such as increased liquidity and the ability of various companies to buy goods with local currency. Banks and other financial institutions often engage in forex currency trading, but individuals can trade currency pairs as well. Forex currency trading can take place around the clock because the market only closes down on weekends.
Modern forex currency trading began in the 1970s, when various countries began to convert from the old Bretton Woods system to floating exchange rates. Since the exchange rates between any two currencies could fluctuate at any time, opportunities for trade benefits and speculation were created. The primary function of the foreign exchange market is to facilitate trade, in that it allows a business based in one country to buy goods or services using a different national currency. Foreign exchange markets could tend towards stagnation if this was the only activity present, so other types of currency trading can provide much needed liquidity.
The other types of forex currency trading are typically focused on making money from the fluctuation in exchange rates. Regardless of whether a bank, hedge fund, or individual is participating in the currency trading, the goal is the same. One currency is bought using another currency with the intention of later selling it for a profit. The profit from each transaction is typically very small in comparison to the amount of money changing hands, so a great deal of leverage is often used. This essentially means that a small amount of money is used to buy a large amount of a different national currency, which can result in huge losses if the exchange rate does not swing favorably.
Another way that forex can be used is for something known as the carry trade. This type of forex currency trading involves an institution borrowing in low-yield currencies and lending in high-yield ones. The difference can result in a net profit for the institution and also increase liquidity in the market, just like other types of trading.
If forex currency trading results in the instability of a currency, a national bank may step in to stabilize the situation. These central national banks typically try to stabilize local currencies to control various factors such as inflation, money supply, and interest rates. If the reserves of a national bank are outstripped by private investors, these actions may not be sufficient and the currency may remain unstable.