In order to make a profit in the forex market, one doesn’t necessarily need to be a regular trader. In fact, each time you travel abroad and exchange currencies, you are making use of the forex market, the financial giant that overshadows all the other money industries.
Nevertheless, the concepts on which this amazing, and apparently overwhelming, financial market is based are quite simple. We will examine some of the fundamental notions that any foreign currency investor must know and understand.
The Eight Dominant Economies
If stock market shareholders have at their disposal thousands of shares to make a choice from, in the Forex world you only need to be aware of the opportunities these 8 dominant economies provides you with:
These 8 countries have developed the most complex financial markets available worldwide, releasing economic data almost every day, and allowing investors to accurately assess each country’s wealth and economy and thus earn interest income.
Yield and Return
Forex functions on a simple equation: investing drives gaining.
Trading in a spot market means you are buying, then selling, two basic currencies. Currencies are always priced in pairs, their value being related to one another. Let’s take for example the USD/EUR pair: if the quote is 1.4500, it means you need $1.45 to buy one euro.
Foreign exchange transactions imply buying a currency and selling a different one at the same time. What you are actually doing is using the profit from the sold currency to buy another currency. What’s more, the central bank of the currency’s country establishes an interest charge, obliging you to pay the interest for the sold currency and, at the same time, earn the interest on the bought currency.
Leverage is another Forex key concept. Sometimes as high as 100:1, leverage allows you to manage $10,000 worth of riches with a $100 capital. Nevertheless, leverage can be tricky: when one is right, it can generate huge profits, but, when one is wrong, it can cause huge losses. Nonetheless, losses can be covered using stops, and many forex brokers use a margin watcher – a special software that monitors your status and liquidates automatically when the margin is reached, limiting the risks and preventing negative account balances.
Carry trading is one of the most famous trading strategies, generated by the dynamic nature of currencies. Carry traders not only earn the interest rate between two different currencies, but they are also able to appreciate its value.
For example, towards the end of 2004, a positive yield of 2.5% was offered by the AUD/USD pair. At first sight, it may seem small; however, using a 10:1 leverage, the return becomes 25%.
The Success of Carry Trading
An efficient carry trade strategy goes beyond pairing up a currency with a high interest and a currency with a low rate. The dynamics of each currency, controlled by the respective central bank, plays a crucial role, as you must take into account the interest rates fluctuations. To sum up, a growing, positive yield, compounded with a potential value appreciation can generate bigger befits.
Currency appreciation and depreciation can consistently make your earning fluctuate.
Knowing the Interest Rates
A good understanding of a country’s economy can help you estimate the direction interest rates are heading. Put simple, countries that are doing well, with solid growth rates and growing inflation rate, are more likely to raise interest. On the contrary, countries facing serious economic problems are more likely to reduce interest rates.
A New Opportunity
In the era of online trading networks, forex trading has become more convenient than ever and this huge financial market provides investors with endless trading opportunities. All it takes is the patience to learn how to trade.