3 Basic Forex Market Concepts
The foreign exchange market is not just for those who trade frequently; whenever you exchange your money for another currency overseas, you participate in the forex market. The forex market dwarfs all other capital markets in the world, becoming a quiet finance giant.
The concept of trading currencies is simple despite the market’s overwhelming size. All forex investors should be familiar with a few basic concepts.
8 majors of Forex
There are only eight major economies to follow in the currency market, unlike the stock market, with thousands of stocks to choose from. Forex transactions dominate by these eight economies, known as The Majors.
- United States (U.S. dollar)
- Eurozone (Euro)
- Japan (Japanese Yen)
- United Kingdom (Pound Sterling)
- Switzerland (Swiss Franc)
- Canada (Canadian dollar)
- Australia (Australian dollar)
- New Zealand (New Zealand dollar)
Forex trading dominates these economies’ financial markets, which are the largest and most sophisticated in the world. For example, 88.3% of all foreign exchange transactions occur in the U.S. dollar and 32.3% in the euro.
As a result of their tendency to reflect changes in global commodity markets, the smaller currencies are known as commodity block currencies.
We can earn interest income from the most liquid and creditworthy instruments in the financial markets by concentrating our efforts on these eight countries. Almost daily economic data is released from these countries, allowing investors to assess the health of each economy as it develops.
Predicting price movements
Buying and selling underlying currencies in the foreign exchange spot market is a two-way transaction. Each currency has a value for another, which is why all currencies have pairs. In the EUR/USD pair, for instance, the price of a euro is $1.22 if the quote is 1.2200.
Futures and spot market bets on currency movements are one of the simplest Forex trades. The euro might strengthen if a trader believes that the European Union’s economy will outgrow the United States. People who believe the U.S. will outperform other major currencies may sell them for dollars.
The same applies to currency futures. Trading currencies in futures contracts takes place at a pre-agreed price at a future date. One of the traders will make a profit if the actual currency price on that date differs from the futures price.
How to win with carry trades?
Successful carry trades require more than pairing a currency with a high-interest rate against one with a low-interest rate. Carry traders are more likely to succeed if they pair currencies with rising interest rates against those with falling rates.
To do this, one must have a solid understanding of the economics of the respective countries. The interest rates will likely be raised in countries with strong growth rates and high inflation rates to tame inflation.
Trading with positive and growing yields that have the potential to increase in value is the most profitable strategy. Currency appreciation can enhance your carry trade earnings, but currency depreciation can also wipe out all of those gains.
Bottom line
Forex trading has become more accessible thanks to electronic trading networks. If investors take the time to learn how to mitigate the risks of trading and understand the largest financial market in the world, there are vast opportunities for them.
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