What is Forex?
In order to fully understand how to trade in the foreign exchange market, I would highly recommend that one first learns all there is to know about Forex (FX). In the simplest form, trading on the FX market is buying or selling one currency in exchange for another, and these currencies are quoted on the market as pairs. An example of this would be the EUR/USD is the price of US dollars relative to euros.
Learning about FX is best addressed by learning about two major topics, namely which markets and currencies affect one another, and following the news.
Which Markets and Currencies Affect One Another
In short, FX is strongly influenced by the strength of a specific country’s economy. There are a few major factors that influence a country’s possible economic growth or recession:
- Some countries like Canada have currencies known as commodity currencies. The Canadian Dollar is known as a commodity currency because the Canadian Dollar moves in an equivalent way to a change in the world price of oil.
- The political landscape in a country can have a significant impact on the country’s currency. If a country is experiencing political unrest, then investors will be wary of investing in any goods from that country or holding the country’s currency. New political leaders have different economic policies which can be either good or bad for an investor but that risk is something some investors may want to avoid.
- Most importantly, significant economic figures such as GDP or unemployment rates can be used as very helpful indicators for predicting the future trend of a countries economy. By predicting the future of the countries economy we can then, in turn, predict the future trend of the countries currency.
For a more in-depth explanation and evaluation of economic events and how they are interconnect check out this book in the link here.
Following The News
Considering the significance of economic statistics, it is essential for traders to follow the news to ensure they can effectively evaluate the FX market and make appropriate trades. Many market indicators follow a consistent path and by properly reacting to that news an investor can get an edge. There are many different examples of reports that are announced periodically to indicate economic direction, like the U.S. unemployment situation summary, which depending on the outcome can have a predictable reaction.
- Example: Nonfarm payroll
Nonfarm payroll is a term used in the U.S. to refer to any job with the exception of farm work, unincorporated self-employment and employment by private households, nonprofit organizations and the military and intelligence agencies.
- Asset value change and effect on a currency
If Payroll numbers are below expectations then the Fed would be forced to keep interest rates low for an extended time period. This gives an indication that the economy is doing worse than expected and many Forex traders will sell the U.S. dollar in anticipation of it decreasing in value. If Payroll numbers are above expectations, then the Fed may scale back the pace of asset purchases. This will lead to Forex traders expecting the value of U.S. dollar to increase encouraging them to purchase more of the U.S. dollar.
Knowing which way the assets will most likely move can allow the traders to capitalize on these changes with proper risk evaluation.
FX can be a tricky industry to trade in the United States as the government has very strict regulations regarding the FX market.
Additionally, there are many different brokers out there and not every one of them truly has the investors best interest in mind. Choosing the right broker can be just as important as the actual trades made.
The most essential thing to check when analyzing a potential broker is to make sure that they are being regulated. This means they should be a member of the National Futures Association (NFA) and should be registered with the U.S. Commodities Futures Trading Commission (CFTC).
These are just some of the basic concepts that are essential to understand before you decide to start Forex trading. Even if you do everything I recommend above, making a profit from Forex trading can be very challenging. You will significantly increase your chances of being successful if you follow how markets and currencies affect one another, and follow the news.