Understanding What Forex Trading Is All About
First , forex trading, like other speculation forms , has a goal that is more important than anything else ; bring in money! If this premise is what we start with , that making money is our goal , then in a massive global market market, how do we do this ?
First you must decide whether you’re a fundamental or technical trader, or perhapse both . Later we’ll have more articles on this topic , but we’ll assume for now that you keep track of current events and world affairs and you are more attracted to fundamental trading . You would then need to ask yourself , what fundamental factors are the most important driving the currency movements ?
If focusing on the fundamentals , one main thing is going to drive the decisions you make in forex trading; differentials in interest rates between countries . What exactly is an interest rate differential ? That is a very good question! Let us suppose that the Australian Dollar has a short term interest rate of 4% . This means that if you live in Australia and you’re in debt this will be the base rate that determines what you pay on your home mortgage, your credit cards, etc . This also means that if you are a creditor you can use as the base rate this 4% short term interest rate that decides how much your investments make; which can include certificates of deposites that come from a bank locally. Now let’s suppose the US Dollar has a short term interest rate , set by the Federal Reserve , at only 1% . So how in the world does what I just said affect currency movements ?
If the short term rate of the Australian Dollar is 4% and the short term rate of the US Dollar is 1% it comes down to something really as simple as this : investors will seek a higher yield on their investments and because they can get more interest in Australia then they take funds and move them to Australia. The investment shift of capital leaving the United States and moving to Australia leads to a weakening of the US Dollar because the supply suddenly becomes greater than the demand and this strengthens the Australian Dollar since the demand is greater than its supply. The basics of economic fundamentals are working; where there is more demand for something its value will rise .
Next time you think about your forex trading and your next position, ask yourself , ” what country has the most liklihood of having higher rates moving forward and what country is likely to have lower rates moving forward ?” Purchase currency that is the high interest rate favorite and currency favored for lower interest rates should be sold and watch your profits grow as investors flows leave the weaker currency and flock toward the stronger one . This is the essence of forex trading.