Ride the forex juggernaut

Foreign exchange (FX) is a whopping great juggernaut of a market, shifting trillions of dollars worth of transactions on a daily basis – dwarfing all others. It is an OTC (over-the-counter) market, so it has no fixed abode and operates globally through brokers and institutions, and since the dawn of the internet has been accessible to retail traders.

Personally, I am not a player as I find equities more interesting, but you do need to know what’s going on in these markets and how they operate because foreign exchange impacts pretty much everything else. More on this later.

At Money Observer's sister website Interactive Investor we are seeing a surge of clients moving into this arena. This growing popularity is partly due to its familiarity for retail customers and also the wealth of education available. However, the main reason for switching to FX is stability.  

Current levels of volatility in equities, coupled with underlying low volumes, are causing a higher occurrence of stock gapping. This is when price spikes are exaggerated due, news flow aside, to low volumes. It is the sworn enemy of short-term spread betters because, when trading on leverage, spread betters can find themselves in hot water very quickly. The difficulties in the current equity environment is boosting an influx of switchers to FX.

The FX market follows the sun, trading 24 hours per day, five days a week so there is no out of hours gapping to contend with and no sleepless nights wondering how the market will open the next day.

Unlike shares, currencies are quoted in pairs and you are speculating on the strength of one currency against another. So, for example, GBP/USD, or as it is commonly known, ‘Cable’ (so called due to the transatlantic cable which used to carry this information between London and New York), is the price for the British pound versus the US dollar. In this instance, GBP is what is called the base currency, which denotes the first currency in any pair. The USD is the ‘term’ currency. As sterling is the base currency any price rise will indicate strength and a fall is weakness. The inverse will be true for USD.

So what makes currencies move? There are many factors but the overriding driver of any currency is confidence. You just have to take a look at the euro’s performance of late to see what I mean. Overall we are seeing weakness and price volatility on a daily basis as confidence waxes and wanes while eurozone leaders jump from one problem to the next.

Many commentators and harbingers of doom are saying that the euro is destined to fail. In that case it is now probably a good time to buy because when everyone belatedly jumps on the bandwagon, markets often turn the other way. In other words the euro selling cycle may already have ended.

Assessing the economic data coming out of a particular region is another barometer that has a direct impact on currency movements. If an economy is growing at a faster rate than its pair, it may indeed strengthen against that currency but this is just one factor. It’s a good idea to keep an eye out for the big numbers and have an economic calendar to hand. Biggies to watch for are jobs data, GDP numbers, inflation, manufacturing and interest rates expectations.

Remember, the dollar (or the greenback as it is affectionately known, which refers to the colour of the paper money first introduced during the American Civil War) is also known as the world’s reserve currency as it underpins economies the world over. Loss of confidence elsewhere in the world can often cause a surge in demand for the dollar even if the US economy is having severe problems of its own. So supply and demand is another factor.

Fundamentals aside, any decent FX trader will have at least a basic understanding of technical analysis. In fact, to the trader, technical analysis is more useful and relevant when used in conjunction with trading currencies. Key to technical analysis is understanding support and resistance levels and being able to identify trends over varying timescales. If you spend some time researching a particular currency pair using technical analysis it should pay dividends.

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