People exchange currencies for different purposes. However, mainly, those purposes are commercial and financial. The commercial purpose has to do with trade. You can be in the United States and sell your products to France, for example. The Frenchman has to pay you in dollars for your goods.
As such, he will have to exchange euros that will be the equivalent value of the dollar worth of the goods. The other purpose of exchanging currencies is in the area of speculation. And that is what we will be dwelling more upon here. But before we do, let’s talk about the history of Forex first.
A History of the Forex Market
The Forex Market has been in existence for as long as man has been using currencies. However, still, it is arguably the youngest of all financial markets. The Forex Market, as we know it today, is a product of the evolution of economic events and policies over the years.
In 1944, delegates from 44 countries met in Bretton Woods, New Hampshire, United States, to develop a monetary system that would stabilise the global economy. The resultant system, the Bretton Woods System, required countries to tie their currencies to gold.
As a result, the volatility of international exchange rates was minimised. However, the agreement lasted only until August 1971 when the tying of the dollar to gold became terminated and currencies were allowed to freely float. Since, they have been varying in value, creating opportunities to profit from.
However, those opportunities were not immediately available for all. In fact, the Forex Market was first the exclusive playground of large multinational companies, investment banks, and pension funds. Individual investors were completely left out. That only started to change recently with the emergence of the internet.
Now, individual investors, known as speculators, even with their small capital, can easily participate in Forex trading Signal.
What is the Forex Market?
As shares of companies are traded on the Stock Market so are the currencies of countries traded on the Foreign Exchange Market. The Forex Market, however, has unique characteristics. For example, it is an entirely electronic market, with transactions conducted over the counter across numerous countries.
As a result, it does not have a centralised, physical market place. Also, it is open 24 hours a day, five and a half days a week, from Monday to a part of the weekend. And since it spans the world’s major financial centres, from London and New York to Tokyo and Sydney, it hardly sleeps, irrespective of the time zone.
According to a 2019 report from the Bank of International Settlements, the daily turn over of the Forex Market is in excess of $5 trillion. This makes it the largest financial market in the world. Consequently, it is highly liquid, with trades always promptly filled.
Speculating in the Forex Market
A Forex Market Speculator seeks to profit from the differentials in the relative values of currencies. His goal is to buy a currency pair when the exchange rate is low and sell it when it is high. As a result, he is always on the lookout for those critical factors such as interest rates, geopolitical instability, and the balance of trade etc. that influence the exchange rates of currency pairs.
Basically, most Forex Market Speculators, also known as retail Forex traders, approach the market using either Fundamental Analysis or Technical Analysis. Some others, however, use both. While Fundamental Analysis examines those critical factors, Technical Analysis is only interested in assessing how the changes in them play out on the charts.
So, how can those factors affect exchange rates? Let us use interest rate and geopolitical stability to demonstrate that.
Interest rate is a vital economic factor that affects the exchange rates of currencies. A country with a higher interest rate will have more investors demanding for its currency than one with lower. As a result, the value of such currency will increase. That is, generally, when interest rates rise, the values of currencies rise, too.
Interest rate differential has become the fundamental basis for a number of Forex trading strategies. One is “carry trade.” Such strategies generally recommend that you long a currency with a higher interest rate while you short the one with lower.
Geopolitical stability affects the exchange rates of currencies because safety is very important in investing. A country with security problems, for example, can be perceived as a terrible place to do business. As a result, investors might either avoid it or draw their capital from it.
Such a situation creates a falling demand for its currency. And with that come a falling exchange rate, too. Conversely, a country with political and economic stability is an attraction site for investors.
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