How To Approach The Foreign Exchange Market
There is a lot of mystique about foreign exchange trading
. And probably rightly so too, it is after all one of the riskiest financial markets you can trade. In this article, we will take you through the reasons this market is so risky and hopefully to some extent, take the mystery out of the market.
Firstly, what is the Foreign Exchange market anyway? What are we trading? Its simple really, we are trading money from different countries. We buy money (which is called currency) in one country by selling currency from a different country. Its an extremely important market for the proper functioning of the global economy. You may not be aware of this, but as a consumer, you have almost definitely participated in this market either directly or indirectly, and probably do so every day.
Maybe it was in the course of a vacation out of the country, or on a business trip, that you had to use local money for transactions. Whether you were operating with traveler's cheques, hard cash or on credit, during the course of any transaction there was an exchange that took place. Right away you will realize that the FX Market has been a part of your life.
Often, we are involved in the exchange market indirectly, as consumers who purchase goods from another country. Anything imported was either bought or sold with an exchange in currency. Next, a calculation by the importer will set the price for the foreign goods in the country where it will be sold, taking the entire scale of exchange into account. While you might have forgotten that it took this sort of arrangement for foreign goods to make their way to local stores, it happens every day of the year. The FX market has everyone involved, from tourists to exporters, from consumers to importers. The exchange of currencies makes it happen.
Why do the value of particular currencies change? The basic reason why the price of a currency changes is simple, its supply and demand. When there are more people who want to buy a specific currency than there are people who want to sell it, the price goes up. (Ie. those who want to buy, will offer a higher price to attract more sellers into the market.) Conversely, When there are more people who want to sell a specific currency than there are people who want to buy it, the price goes down. (Ie. those who want to sell will offer a lower price to attract more buyers into the market.) Thats the simple answer.
The hard part is determining the root of supply and demand fluctuations. Therein lies the complex part of foreign currency exchange. Not even economists can pinpoint exactly the cause of demand and supply changing like the tides. Being a good trader is having a grasp on the big factors and investing accordingly, but there is definitely no simple answer and thus the market of currency exchange is not a simple game to play. There are no formulas.
The currency figures of a particular country represent the economic value of that country, thus compared against that of another country. When you start to consider the endless number of factors which can affect an economy in one direction or another, and how some of them defy all logic, you will see the dilemma of anyone who is trading currency for a living.
But your countries economy is only half the equation. We are not measuring the value of your economy alone, rather comparing it against the economy of a different country. Therefore, even if you have a really good understanding of your own economy, you need the same understanding of the other country's economy also.
On top of that, your currency will be stacked up against the entire world's currencies. At this point you need a truly global perspective, weighing extremely diverse factors, before you decide one country's currency will spike in value while another will remain stagnant.
And if you manage to get all your analysis correct, you then need to hope everyone else does too. Currencies can move on investors opinions, expectations met or expectations not met, global sentiments of what is likely to happen as much as global opinion of what has happened. There are fundamental traders (who look at information such as the above to make their decisions) and technical traders. (who just follow graphs and don't care why) Both trader groups can impact the price as they impact supply and demand.
There are even people who buy currencies months and years in advance to lock in a price, to help support business activities unrelated to FX trading. This also impacts price. So you can start to see what a complex equation this can become.
Then there are Foreign Exchange Trading Strategies which don't need to predict if a currency is going to go up or down. It doesn't matter which way the traded currencies move, they make small incremental profits in both directions.
I hope this helps take some of the mystery out of the FOREX market.
by: Damian Papworth
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