How to Trade Currency

You can trade currency by investing directly in currency markets, currency-related securities such as exchange-traded funds, or via electronic currency trading platforms. Advances in trading technology have made currency trading much more accessible to individual investors, particularly growth in the number of ETFs that allow you to invest in various currencies through regular brokerage accounts. Securities such as ETFs and futures allow you to, in effect, sell currency without first owning it by focusing on movements in the underlying currency values.

Direct Investment

You can exchange your U.S. dollars into another currency at the going spot rate through commercial banks and other foreign exchange dealers. This means you are actually investing directly in a particular currency at the exchange rate currently available. For example, if the spot rate for trading U.S. dollars to euros is $1.50, you can buy one euro for each $1.50 you exchange. If you bring $150 to a bank, you can exchange it for 100 euros.

Derivatives Market

Derivatives are securities whose values are based on an underlying asset, such as currency or stocks. The most widely used currency derivative is the futures contract. Futures contracts are standardized contracts to buy or sell (go long or short) certain currencies at either the spot or forward rates. Forward rates are akin to what investors expect the spot rate to be at a future date. They are the price at which you can buy or sell a currency at a future date. Currency futures contracts change values at tiny increments, usually a basis point.

As an example, suppose the notional amount for each euro futures contract is 125,000 euros, and the contract value fluctuates in increments of $0.0001 (0.00005 in euros). If you go long one contract today, and at the end of the day the euro has appreciated by 4 basis points, you would have a gain of $50 -- the 4 basis point increase multiplied by $0.0001 multiplied by 125,000 euros. You can exit the trade by taking the reverse position -- selling a contract that you've bought, or buying a contract that you've sold. You don't need to actually physically deliver the underlying currency. That function is provided for by clearinghouses.

Exchange-Traded Funds

ETFs are funds that track underlying securities, such as currencies, and trade on stock exchanges just like stocks. Through ETFs, you can trade in a specific foreign currency via a low-cost, liquid investment vehicle, which is why ETFs have greatly proliferated throughout the investment world. If you believe a currency will rise, simply purchase shares in an ETF with a focus on that currency using the same brokerage account and inputs (ticker symbol and number of shares) that you would when trading stocks. There are also ETFs that employ leverage to boost returns, or invest in baskets of stocks.

Digital Currency Trading Programs

A number of companies, including DirectFx, FXCM and R.J. O'Brian & Associates, have developed trading platforms that make trading currencies extremely straightforward. While ETFs make currency trading simple, these trading programs are actually the simplest options. The programs replicate currency markets by tying in the program's returns to the selected currency. Once you open and fund an account with one of these companies, you trade by selecting a currency, choosing between a long or short trade, and choosing the amount you wish to invest. As the currency value fluctuates on the forex market, your account value fluctuates at the same rate. It is a simpler option, because it eliminates the details associated with contract specifications, and instead focuses on percentage returns.