A currency exchange rate reflects interest rate policies as well as macroeconomic factors such as economic growth, inflation, and unemployment.
Basic Fundamental Conditions in the Foreign Exchange Market
Primarily, an exchange rate is influenced by a combination of the following fundamental conditions:
(i) growth, inflation, and unemployment
(ii) monetary policies, and especially the interest rate policy of the central bank
(iii) fiscal policies & government spending
(iv) political stability (political risk)
(v) legislation regarding capital taxation & the openness of the domestic economy
New macroeconomic developments can create trading opportunities in the Forex market
The Forex market is highly efficient, with news impacts quickly reflected in exchange rates. However, major shifts in the broader macroeconomic environment can present significant opportunities for traders. In fact, all key Forex trend reversals are driven by such macroeconomic shifts.
Introduction to the Foreign Exchange Market
With daily volumes exceeding USD 5 trillion, the Foreign Exchange Market, or Forex, is the largest financial market in the world. It operates as a decentralized network where the world’s major currencies are traded against one another on a 24-hour basis, from Monday to Friday.
The Short History of the Modern Currency Market
After the end of World War II, the Bretton Woods Agreement (1944) laid the foundation for a new global monetary system. Under this agreement, a country’s currency was pegged to a specific quantity of gold. When the Bretton Woods system ended in the 1970s, it gave rise to the modern Floating Currency System. In this system, the value of each currency fluctuates based on supply and demand dynamics.
- In 1971, the CME (Chicago Mercantile Exchange) became the first exchange to offer currency trading through the International Monetary Market (IMM).
- Following 1990, advances in information technology paved the way for a fully computerized trading environment—today known as the Online Forex Market.
More: » World’s Exchange Rates History
Today, hundreds of online brokers provide access to the Foreign Exchange Market. These brokerage firms typically fall into three main categories:
(1) ECN Brokers (Non-Dealing Desk)
(2) STP Brokers (Non-Dealing Desk)
(3) Market Makers (Dealing Desk)
More: » Brokers for Forex Investors
Risk Management in Foreign Exchange Investing
Like all financial markets, the Foreign Exchange market carries various risks. Therefore, effective risk management is essential for achieving long-term profitability. This analysis outlines the major currency risks and provides specific recommendations for managing them.
Six Major Risks
There are six (6) key risks associated with investing in the Foreign Exchange market:
(1) Exchange Rate Risk
Exchange rate risk is a form of market risk that arises from unfavorable fluctuations in exchange rates. Every active Forex position is exposed to this risk. While it cannot be completely eliminated, its impact can be significantly reduced.
Hedging Against Exchange Rate Risk:
Here are some basic strategies to hedge against currency risk:
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Diversifying your investment portfolio
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Implementing a comprehensive Money Management (MM) system
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Trading with smaller position sizes
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Minimizing the use of leverage
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Identifying and managing potential correlations between different currency positions
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The Contents
This book provides all the essential knowledge required to trade equities, Forex, and cryptocurrencies.
Chapter 1 introduces the fundamentals of analysis for equities, Forex currencies, and cryptocurrencies, and reveals seasonal patterns for the Dow Jones Industrial Average, three major currency pairs (EURUSD, GBPUSD, and USDJPY), and two key cryptocurrency pairs (Bitcoin and Ethereum against the US dollar).
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Foreign Exchange Cyclicality & The Role of Central Banks
Recognizing the macroeconomic cycle and interpreting the intentions of central banks are two key factors in achieving long-term success as a Forex investor.
Identifying Two (2) Major Types of Forex Currency Cycles
It is essential for any Forex investor to understand and capitalize on the cyclical nature of the Foreign Exchange market. There are two primary types of cycles in the Forex market:
(i) Long-Term Macro Cycles
Over the long term, currency movements tend to align with the broader macroeconomic environment and follow the interest rate cycle. The monetary policies of central banks play a significant role in shaping these macro cycles of exchange rates.
