The term “floating” is used for exchange rates in forex trading. Simply put, a floating currency is not pegged or fixed in value against any other currency. Instead, it moves according to demand and supply factors in the international foreign exchange market.
What to know when floating in the forex market?
- Always use stop loss and profit target levels when entering/exiting a trade- this will help keep your losses and profits in check. Remember, you may be right on the direction of the trade but wrong on the magnitude; using stops will ensure that you break even on your trades.
- Do not become emotionally attached to your positions- one of the biggest dangers of trading is letting our emotions get in the way of our judgement. Remember, we are in this game to make money and not prove a point. If we lose on a trade, so what? As long as we follow our rules and keep taking winners, we should be profitable in the long run.
- Always ensure you have a positive expectancy- if we divide our total gains by our total losses in a particular trade, the value will tell us how much we would have made on an average per trade basis. It again shows us that floating is a good forex trading style because we have a positive expectancy.
Floating in “simple” term
In simple terms, a floating trader invests with a movement of around 5-7% and then uses stop loss and profit target levels for exits. There is no set figure on how much we should move after investing; we can do 10pips one trade and 0.5 pips on another trade. It all depends on our analysis, risk appetite and level of confidence at that particular point in time.
The most common methods of trading currencies
Spot trading
The most common method of trading currencies is known as spot trading. It involves simultaneously buying one currency and selling another in a pair, with settlement based on a predetermined price for two currencies at a particular time in future. In this manner, payment by either party for the transaction does not take place until the agreed-upon date when both currencies are exchanged at their previously determined prices from that date. Such transactions can be carried out over-the-counter (OTC) or on exchanges.
Pegged currency
In contrast to a floating currency, a pegged currency is fixed at a particular value against another currency or basket of currencies. Central banks will often peg their money to maintain economic stability, control inflation, and protect their export sector. Monetary policy is generally easier to administer when the central bank can set a fixed rate for its domestic currency.
However, if the pegged currency becomes overvalued or undervalued in the market, it can cause economic distortions. For example, persistent excess demand for a pegged currency (driving up its value) can lead to excessive inflation as imports become more expensive. Conversely, the constant excess supply of a pegged currency (driving down its value) can lead to a recession as exports become cheaper.
FX forwards
The other primary method of trading currencies is known as FX forwards. It involves agreeing to exchange money at a predetermined rate on a future date. Unlike spot trading, there is no actual settlement of the transaction when the contract is made. The forward contract guarantees that the two currencies will be exchanged at the agreed-upon price on the future date. Forwards can be used for hedging purposes, as well as for speculation.
So which is better: floating or fixed rates?
In general, floating rates are more volatile but provide more opportunities for traders to profit from changes in exchange rates. Fixed rates offer more stability but may not reflect market conditions and may not be advantageous to traders. There are many uncertainties surrounding currencies and interest rates in the current global economic environment. It makes floating rates more risky but also potentially more rewarding. FX traders need to consider their goals carefully and risk tolerance before deciding which type of rate to use.
Still unsure about what rates to use? Find more info here.
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