The foreign exchange (forex) market is intimidating when encountering it for the first time. An endless sea of foreign currencies being bid up and down, it is seemingly without reason or purpose. Yet this is the largest and most liquid financial market in the world. Trillions of U.S. dollars’ worth of currencies flow in and out of the forex market on a daily basis. The forex market accomplishes multiple purposes, perhaps the most important of which is facilitating international trade. Multinational corporations use it to move profits and revenues from one country to another. Central banks use it to execute domestic monetary policy objectives.
Forex trading sounds more complicated than it actually is. Speculators must begin by understanding the events that move the forex market. They are similar to the events that move the stock market: wars, economic booms or depressions and natural disasters. The preeminent example of a natural disaster affecting the forex market is the March 2011 Japan earthquake. The extremely powerful quake damaged a significant portion of Japan’s inland infrastructure as well as triggered a nuclear crisis. The forex market quickly reacted, sending the Japanese yen down to ¥78 against the U.S. dollar by March 17.
The Bank of Japan, in turn, intervened, sending the yen back up to ¥84 against the dollar by April 7. Central bank interventions are another event that moves the forex market. Ever since the earthquake, the Bank of Japan has intervened in the forex market in futile attempts to keep the value of the yen weak relative to other currencies. The yen continues to stubbornly appreciate against the dollar to this day however. Traders must understand these events as they relate to their own moves within certain currencies.
Traders have to understand the exchange rate, the basic pricing mechanism of forex. An exchange rate is the price of one currency in terms of another, like the price of the U.S. dollar in Japanese yen. Exchange rates are represented by currency pairs like USD/JPY, which are the international symbols for the dollar and the yen respectively. Traders use currency pairs to execute their trades. When they buy the USD/JPY, they are selling the U.S. dollar and buying the Japanese yen. If the yen appreciates against the dollar, they make money, and if it declines, they lose money.
Another technique is known as the carry trade. This involves taking advantage of the interest rate levels in different countries. Carry traders sell the currency of a low-rate country and buy the currency of a high-rate country. They profit off of the difference between the two rates. Carry traders have to be cautious because currency fluctuations mean their trades can be wiped out instantaneously. After the yen started to appreciate after the March earthquake, traders who used the yen as the basis for carry trades found themselves wiped out.
Traders looking to get into the forex market need the right firm. Contact Lucror FX at www.lucrorfx.com. A good company can make all the difference helping traders navigate their first steps.