Classification of Foreign Exchange Speculative Transactions

As is well known, foreign exchange trading is a high-risk investment activity. Due to the high risk, investors may receive substantial returns. For investors, one of the most important skills is learning to avoid foreign exchange risks, which has led to the trading model of foreign exchange speculation. So what are the types of foreign exchange speculation?

Types of Foreign Exchange Speculative Trading

(1) Spot trading

Spot trading is the most common form of speculation. Most speculators in the world engage in spot trading, usually buying and selling on the same day without leaving overnight open positions. But if speculators believe that their judgment on the trend of exchange rates is relatively accurate, they can also hold a certain position for several months without trading on the same day in order to seek greater returns.

(2) Cross-arbitrage

The initial use of arbitrage for speculation is location arbitrage, which means that before the financial market is underdeveloped, communication methods are incomplete, and the global foreign exchange market is not integrated, the exchange rate levels of different financial centers may be inconsistent, allowing speculators to buy a certain currency in one place and sell it in another place to profit. This is a two-point arbitrage, and more complex ones are triangular arbitrages. But now, with the integration of the global foreign exchange market, such opportunities have rarely appeared.

(3) Using other currency trading methods for speculation

With the further development of the foreign exchange market and the continuous emergence of financial derivative products, the scope of foreign currency speculative transactions is also becoming increasingly widespread. Option trading and futures trading have become good tools for speculators to use. Regardless of the type of transaction, the principle is to "buy low and sell high". Speculators buy at lower prices and sell at higher prices based on their own predictions of exchange rate trends in order to gain speculative profits.

(4) Margin trading

When speculators engage in speculative trading, margin trading provides them with an opportunity to engage in larger transactions with less capital. Margin trading has become the main form of foreign exchange speculation. Margin trading refers to an investor opening a margin account with a broker, and with the consent of the broker, the trader can use this margin as collateral to engage in foreign exchange transactions several times the value of the margin, with profits and losses recorded in the margin account. The current margin ratio for domestic banks is 5% to 10%, which means that investors can engage in transactions equivalent to 10–20 times the margin amount. However, among foreign brokers, some companies can provide 500 times the leverage. Margin trading has great appeal for both investors and brokers, but the risks are also considerable.

In the international foreign exchange market, countless traders are engaged in speculative foreign exchange trading. Speculative behavior is the lubricant of the foreign exchange market, and without speculation, the foreign exchange market will be difficult to operate effectively. But speculative behavior can also bring turbulence to the market, making the fluctuations in exchange rates more drastic. According to the survey results of the Bank for International Settlements in April 2007, the daily trading volume of the world foreign exchange market at the beginning of the year had reached 32 trillion dollars, of which speculative transactions accounted for a large proportion. In financially developed countries and regions, not only banks, financial institutions, and large corporate consortia engage in speculative foreign exchange transactions, but some small businessmen and even ordinary people also participate in foreign exchange speculation. Of course, they all need to conduct transactions through agencies (banks or financial companies).

(5) Foreign exchange transactions conducted due to the need for foreign currency deposits

In banks, various convertible currencies have fixed deposit interest rates. Generally speaking, high deposit rates result in high returns. Many people like to choose currency deposits with high interest rates, such as pounds, Australian dollars, Canadian dollars, etc. Due to changes in economic and monetary policies in various countries, the deposit interest rates of various currencies are constantly changing. Before 1985, the US dollar had high interest rates, but after that, interest rates gradually decreased, and now they are also at a lower level. Due to interest income, some people hope to exchange their low-interest currency for high-interest currency, which requires foreign exchange transactions. However, foreign currency deposits have foreign exchange risk, so when deciding the deposit currency, the holder should consider not only the interest rate but also the exchange rate. For example, in early 1989, 1 pound could be exchanged for $1.8190, but on June 30, it dropped to $1.5408, a decrease of 15%. The gain on interest cannot compensate for the loss on the exchange rate. Later, the pound gradually rebounded, reaching a 60% increase by June 1990. It can be seen that if chosen well, you can achieve a double harvest of exchange rate difference and interest rate difference; if the choice is not good, you will only have to suffer certain losses.