What’s Is Forex Trading
First , forex trading, like any speculation form, has a goal that is more important than anything else ; make some money ! If this is the premise we start out with, that making money is our goal , how is this achieved in our massive global market?
The first thing you need to decide is whether you’re a fundamental or technical trader, or perhapse both . There will be more articles coming on this topic later , but now let’s just assume you like keeping up with current events and world affairs and the fundamental side of this game is the one you’re more attracted to. Then you must ask yourself , what are the single most important fundamental factors that drive currency movements ?
If you focus on the fundamentals, forex trading decisions are going to be driven by one thing above all others ; differentials in interest rates between countries . What exactly is an interest rate differential ? Good question ! Suppose there is a short term interest rate of 4% on the Australian Dollar . This means that if you’re a debtor in Australia this is the very base rate determining what you’re paying on mortgages, credit, and other debt. Also, if you happen to be a creditor you can use as the base rate this 4% short term interest rate that will determine how much interest income you make on your investments ; such as CDs from your local bank . Then imagine that the US Dollar has its short term interest rate , set by the Federal Reserve , at 1% . How are currency movements affected by all this ?
If 4% is the short term rate of the Australian Dollar and 1% is the short term rate of the US Dollar it comes down to something really as simple as this : a higher yield is sought by investors and since Australia provides more interest then they take funds and move them to Australia. This shift in investments of capital flows leaving the US and going to Australia mean that the US Dollar will weaken since demand is smaller than supply and the Australian Dollar will strengthen since the demand is greater than its supply. Economic fundamentals are working here ; value rises when there is higher demand .
Next time you think about your forex trading and what position to put on next , you should ask, “what country is likely to have higher rates moving forward and which country moving forward will probably have lower rates ?” Purchase currency that is the high interest rate favorite and currency favored for lower interest rates should be sold and increase profits as investors leave currency that is weaker and go towards the one that is stronger. This is the essence of forex trading.
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