Forex Trading

Well, first and foremast, forex trading, like any form of speculation, has one very important goal that lies above all else; make some money! So if we start with that premise, that our goal is to make money, then how do we do it in this massive global market?

The first thing you need to decide is whether you are a technical trader or a fundamental trader or both. There will be more articles coming on this topic later, but for now let’s assume that you like to follow world affairs and current events and are therefore attracted to the fundamental side of the game. You would then need to ask yourself, what are the single most important fundamental factors that drive currency movements?

If focusing on the fundamentals, there is one thing above all else that will drive your forex trading decisions; interest rate differentials between countries. What is an interest rate differential? Good question! Let us suppose that the Australian Dollar has a short term interest rate of 4%. Meaning that if you are a debtor and you live in Australia this will be the base rate that determines what you pay on your home mortgage, your credit cards, etc. 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 will determine how much interest income you make on your investments; things like certificates of deposits (CDs) at the local bank. Now let’s suppose the US Dollar has a short term interest rate, set by the Federal Reserve, at 1%. So how in the world does what I just said affect currency movements?

If the Australian Dollar short term rate is at 4% and the US Dollar short term rate is at 1% it comes down to something really as simple as this: investors will seek a higher yield on their investments and because they can get more interest in Australia they move their funds “down-under” or as the Aussies say, “down-unda mate”. This shift in investments of capital flows leaving the US and going to Australia mean that the US Dollar will weaken because the supply suddenly becomes greater than the demand and the Australian Dollar will strengthen because the demand suddenly becomes greater than supply. Basic economic fundamentals at work here; where there is more demand for something its value will rise.

The next time you are thinking about your own forex trading and what position to put on next, just ask yourself, “what country is likely to have higher rates moving forward and what country is likely to have lower rates moving forward?” Then, buy the currency that you favor for higher interest rates and sell the currency that you favor for weaker interest rates (say buy Aud/Usd using the above example) and watch your profits grow as investors flows leave the weaker currency and flock toward the stronger one.