First , forex trading, like any form of speculation , has one very important goal that lies above all else ; making money ! If this premise is what we start with , that making money is our goal , how is this achieved in our massive global market?
The first thing you need to decide is whether you’re a fundamental or technical trader, or perhapse both . There will be more articles coming on this topic later , 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 are the most important factors fundamentally driving currency movement ?
If the fundamentals is what you’re focusing on , forex trading decisions are going to be driven by one thing above all others ; interest rate differentials between countries . What exactly is an interest rate differential ? Good question ! Suppose there is a short term interest rate of 4% on the Australian Dollar . Meaning that if you are a debtor and you live in Australia this is the very base rate determining what you’re paying on credit cards, mortgages, and more . This also means that if you are a creditor you get to use this short term interest rate of 4% as the base rate that decides how much your investments make; which can include certificates of deposites that come from a bank locally. Then suppose that the short term interest rate of the US Dollar, set by the Federal Reserve , which is 1%. How are currency movements affected by all this ?
If 4% is the short term rate of the Australian Dollar 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 since Australia provides more interest they move their funds “down-under” or as the Aussies say, “down-unda mate” . The investment shift of capital leaving the United States and moving to Australia weakens the US Dollar because the supply suddenly becomes greater than the demand and this strengthens the Australian Dollar because supply is smaller than demand . Basic economic fundamentals at work here ; when there is higher demand the value rises.
When you think about your own forex trading and your next position, ask yourself , “what country is likely to have higher rates moving forward and which country moving forward will probably have lower rates ?” Then, buy the currency that you favor for higher interest rates and sell the currency that you favor for weaker interest rates and increase profits as investors flows leave the weaker currency and flock toward the stronger one . This is the essence of forex trading.
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