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Foreign Exchange Trading - Risks and Rewards
There is much mystique surrounding the foreign exchange market, as far as investing is concerned. And this is probably a good thing, it is afterall one of the most volatile financial markets you can trade in. In this article, we will explain to you why this market is so risky and hopefully to some extent, take the mystery out of it.
To begin with, what is the Foreign Exchange market? What financial instrument are we trading anyway? In a nutshell, we are trading money. Money as it is priced in different countries. We buy money (which the market calls currency) in one country by selling it from a different country. Its an extremely important exchange for the proper functioning of the global economy. And you maynot be aware of this, but as a consumer, you participate in this market almost every day.
Have you have ever gone on a holiday overseas? If so, you would have used currency in the country you visited. It doesn't matter what your medium was, travellers cheques, credit card or cash, by functioning as a consumer in the country you visited, you would have needed to buy local currency with the money you earned back home. With this transaction you participated directly in the FX Market, you were a foreign exchange trader.
Every day participation in the FX market is indirect though, and occurs when you buy imported products at home. Products made overseas are initially sold in the currency of the country they were made. When you buy them in your home country, at some stage someone has made a foreign exchange transaction, translating the price of the product from the currency where it was produced, to the currency where it was consumed. It could be the producer, an importing company or the retailer that does this. It doesn't really matter. When you buy imported goods, the currency translation will have occurred and as such you have indirectly participated in a foreign currency transaction.
Why do the value of particular currencies change? An interesting question. There is a simple and a complex answer. The simple answer is that a currency changes as the supply and demand for that currency changes. To explain, if there are more people who want to buy a currency than people who want to sell it, the price will goes up. (This is the case as those who want to buy it will have to offer a higher price to attract the sellers into the market.) Conversely, When there are more sellers of a specific currency than buyers, the price tends to go down. (Ie. those who want to sell will offer a lower price to encourage people to buy the currancy.)
Thats the simple answer.
The really tough question though, is what changes the forces of supply and demand? This is the real question, and the reason why trading in the FX market so difficult. No-one knows exactly, what all the factors are, that cause supply and demand to change in the FX market. Many analysts have a good idea (or gut feel?) of the major influences, but there are so many variables which impact currencies that it is pretty much impossible to formularise the exact reasons currencies change price.
Currency prices are a measure of a country's "economic value" as compared against another country's "economic value". If you think about the millions of factors which impact people's perceptions of the economy, you can start to understand why predicting FX price movements is difficult. But your 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.
As such, even if you have a steller understanding of your own economy, you need the same understanding of the other country's economy also so you can make your comparison. And your currency trades against all the currencies in the world. So you really should know exactly how each individual economy is going, to compare your economy against the world economies, before making a judgement call about whather you think the exchange rate will appreciate or depreciate.
And if you manage to get all your analysis correct, you then need to hope everyone else does too. Currencies can move on opinions, expectations met or expectations not met, global sentiments, thoughts what is likely to happen and 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 of which can impact the price.
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.
You can really start to see what a complex equation this can become.
Fortunately, the FX trading strategy we recommend works without needing to predict a currency's direction. It doesn't care which way the traded currencies move, it makes money in both directions. I just follow the strategy and make money week in and week out. Read our review and see what you think. Foreign Exchange Trading Strategy. At the very least, it is certainly worth trialling in a demo account (yes you can test this strategy in real time markets without putting any money down. )
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