Almost everyone has had some experience with currency trading. Every time you are on holiday abroad and change money, you are trading the currency indirectly. You buy one currency and sell another, which can influence the currency exchange rate. It is the same principle with Forex. But, due to the huge trading volume, you cannot influence the currency exchange rate if only exchanging a few hundred or thousand. National banks, banks, market makers, export/import companies, investment and hedging companies, insurance companies, corporate investors, and intermediary companies offering individuals and legal entities access to the market all have far more influence on the exchange rate:
Central banks are the major market participants who do not impose any formal limitations on price development. Nevertheless, they act as regulating authorities determining the level of main interest rates. Banks operate on the open market, dealing with repurchases or selling securities, express their preferences to market participants and assess the situation. They may also reserve the right to effect direct currency interventions (purchase or sale of the national currency to prevent a subsequent fall or rise in its cost).
Market-makers are the banks individually quoting currency prices for other participants in the market. They have the right to determine price quotations on the basis of their agreement to adhere to international standards. Service stability, code of laws and rules developed by the regulating institutions (e.g., the FSA which is regulated by the Bank of England), plus the so-called ”honour code” established by market-makers, all secure continuous operation of the Forex market.
Export/import companies effecting currency exchange transactions in the market do not set out to gain direct profit from such transactions but apply international policies for currency exchange so that they can carry out their economic activities instead.
Investment funds, corporate and private investors
Investment funds, corporate and private investors aim to profit from the purchase and sale of currency due to price differences at various times. Intermediary companies gain them access (entry) to the market while receiving market quotations from market-makers i.e., these major participants effect exchange transactions with Forex.
Insurance companies are engaged in risk hedging (insuring transactions against the market risks) in the field of specialized transactions. For example, a company importing products from Germany carries a risk related to a possible increase in the cost of the European currency. It can offset such risks by buying euro in amounts assessed before for any other currencies.
Profit and Loss Trading Forex
It is easy to understand how you can make a profit or loss on FOREX. As mentioned before, you buy or sell one currency and sell or buy another currency - two currencies are involved in a transaction. This is known as a ‘currency pair’. The most traded currency pair is EURUSD. The trading principle is simple: buy low and sell high or vice versa.
You feel that the euro will increase and therefore the exchange rate will also climb. You buy the euro. After a while, the exchange rate has climbed and you think you should complete the transaction and sell the euro. The difference of both exchange rates is your profit. If you buy the euro and the exchange rate falls, you make a loss. It is as simple as that.
It is always advisable to analyse the market before transacting Forex. There are two methods of analysis: fundamental analysis and technical analysis.
The fundamental analysis examines economic and political influences on currency. Every day something happens: politicians make decisions, events occur and economic data is published. Certain factors can influence the currency very strongly while others have no significant influence.
The biggest influence on a currency is a country’s central bank because it determines the monetary policy. The crucial economic indicator is the bank’s key interest rate - its interest rate for lending money. (The exact names for the key interest rate differ from country to country: in the USA, it’s called the ‘federal funds rate’.)
How can the key interest rate influence the currency? If it’s increased, the volume of money supply shrinks and inflation falls. This all leads to a strong currency. If this rate drops, the result is the opposite.
Other important economic indicators are:
Gross Domestic Product (GDP): the monetary value of all finished products and services within a certain country in a certain period (usually a year). The increase of GDP means the growth of the whole economy and has a positive effect on the currency. Any decline influences the currency negatively.
Trade balance: the difference between the monetary value of all exports and all imports of a certain country in certain period. If the trade balance is positive (trade surplus), it means that the monetary value of the country’s exports is greater than the monetary value of the country’s imports. This has a positive influence on the currency. The trade deficit (where the monetary value of imports is bigger than the monetary value of exports) has a negative influence.
Unemployment rate: the number of unemployed workers expressed percent in a certain country. The target of every country is to reach full employment as high unemployment influences the currency negatively.
Technical analysis examines price charts. These reflect the psychology of all traders on the market and economic indicators. The important rule to realise is that history repeats itself because what has happened in the past will happen in the future again. Analyse the history of the price charts and you stand a good chance to predict future price movements. Traders who use technical analysis also try to find certain price chart patterns to help their decisions.
Resistance and Support Lines
- The resistance line connects at least two significant highs and lirevents the exchange rate moving higher.
- The support line connects at least two significant lows and lirevents the exchange rate moving lower.
- The exchange rate can rebound from either line and change direction.
The “ascending triangle” pattern can be found in bullish markets. With this, the resistance line is horizontal and the support line increases. If the exchange rate breaks through the resistance line, it is the possible market entry point. After this, the direction of movement remains the same.