About Trading Forex Pairs
If you are an individual Forex investor, your success will depend upon your ability to read how giant Forex traders will interpret a host of factors that affect the demand for a specific currency compared to the demand for another currency. Forex investors can profit by being on either side of the bet. If the investor senses the currency value will appreciate or deprecate against another currency in a specific time frame, there is money to be made.
Experienced traders deploy strategies to hedge their bets, but for today we will consider the key economic, financial and political indicators that traders use to evaluate the relative strength or weakness of a currency opposed to a paired partner.
Understanding the Forex Marketplace
The Forex marketplace is active and volatile The market is open 24 hours a day for five days every week. The market has no central exchange and currency values can change round the clock as events unfold around the world.
In terms of daily trading volume, the Forex market is the largest and busiest market in the world. The market is global. Currency values are subject to a range of compelling factors that influence traders and therefore the value of a given currency. Like all markets, currency values are measures of supply versus demand.
When the demand exceeds the available supply of a specific currency, the value of the currency rises. Likewise, when supply outweighs demand, the value will lower. When you invest in a pair, you are betting that the value of one currency will rise or decline against a paired partner because demand for that currency will increases or subside compared to demand for the paired partner.
Factors Influencing Demand For Currencies
In an era where central bankers have been needed to keep credit markets open and cash flowing, the relationship between a currency’s central bank and the currency value cannot be overlooked. As the Federal Reserve extends its tapering initiative, the value of the dollar should appreciate.
But, central banks have other concerns than quantitative easing (stimulus). The primary function of central banks is to control inflation. When deflation fears run rampant through Europe, the European Central Bank may be forced to take action and increase interest rates, which would affect the euro.
If the central bank feels the value of the currency is putting its export trade at risk, it may be inclined to flood the market with its domestic currency as Japan has done for the past year. Pouring money into the economy (quantitative easing) has a chilling effect on the currency’s value.
Although many Forex traders closely monitor global equity markets, it is usually easier to gauge market sentiment for equities than it is for Forex pairs. We wake up in the morning to national coverage about equity markets, which are covered throughout the day and night.
There is no denying the existence and brute force of market sentiment. Sometimes, it can seem that market sentiment defies logic but there can be a host of unforeseen events at work that drive market sentiment. At best, market sentiment is fickle and can change at a moment’s notice.
Forex traders cannot afford to be in the dark about political events. Civil wars, terrorist attacks, election results, budget impasses, debt ceiling controversies, government shutdowns, credit rating activity, Congressional stalemates and new government policies all affect a currency’s value. The ability to stay ahead of political events can positively impact the trader’s experience.
Macroeconomics and Forex Trading
Macroeconomics remain the guiding force in currency trades. Gauging and understanding a country’s economic position is the principle that most influences Forex traders, large and small. Macroeconomic reports are strong indicators of a nation’s economic and fiscal well-being.
For example, when true unemployment in the US improves, this is a positive dynamic. However, when the US had two sour non-farm payroll reports in succession, market sentiment attributed the downtrend as weather related and not a reflection of the economy.
In Canada there is concern about household debt and the world’s most overpriced housing market. We have all seen the affect that can have! Economists are watching these troubling trends that have already tuned the CAD lower.
Britain recovery has been partially fueled by the Help to Buy program, an aggressive accommodation for new and existing homebuyers. There are already concerns that this is creating an inflationary force in the UK. Hence, one of the key drivers in the UK’s recovery may well take a toll before long.
At the same time, many national economies are sector driven. Canada relies heavily on its strong energy export trade. When oil prices rally, the CAD adds value. Understanding the factors that drive the economy and are key contributors to GDP is important for Forex traders.
Another key driver of the Forex market is bond markets. The bond market and the Forex market are closely related. Understanding the effect of bond rates upon currency values offers good insight into pairs trading.
The Forex trader need not know about all currencies and countries in order to succeed. Many successful traders concentrate on a few currencies and the economies affecting those currencies.
When trading currency pairs, the trader’s ability to gauge a nation’s economic strength is the most important determination. Forex traders read and study macroeconomic reports and draw unemotional opinions as to the future of a nation and its currency. That is when the Forex trader is ready to trade.