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Three Guideposts for Forex Trading

The canny investor who has already earned some success trading on foreign currency movements also has access to a vast spectrum of news services that undertake to explain trends and cycles in this market. But how is a high-asset individual or fund manager to know what advice to accept and what developments are irrelevant?

In fact, an astute investor need only realize that currencies behave very much like commodities. The value of leading currencies is truly influenced almost solely by supply and demand.

As with many things, supply and demand for foreign exchange is the aggregate outcome of many real-world elements. Rational investors and market-makers agree that these elements mostly have to do with market psychology, economic factors and political developments. A nation's trade surplus (or deficit) is only the best-known of the economic factors that explain the relative value of a currency.

In both the business press and syndicated news services, much is made of the robust yuan because of the large trade surpluses China routinely reports. Similarly, pundits worry about the trade deficits the U.S. routinely runs vis-�-vis China, Japan and Europe; they warn that no matter how these deficits will be financed, there can only be deleterious effects for the value of the dollar over the long term.

Taking a long position in forex markets means keeping an eye on the fiscal and monetary policies of governments. Almost everything that governments promulgate and central banks decree impinge on production, prices, and inflation, to cite just three economic indicators. The healthier or more upbeat the outlook for the economy, the better obviously the prospects for the currency.

Economic fundamentals aside, forex traders also need to be alert to sudden, short-term shocks caused by political conditions and market psychology. The latter is quite amorphous but better understood in terms of investor perceptions and confidence. As well, the psychology of currency markets takes its cue from domestic politics and international relations.

When Israel intervenes vigorously in the Gaza Strip yet again, for example, this reminds the forex investor to sell off any position he has in the new shekel for fear that sustained fighting can only aggravate the chronic deficits of the Israeli government. At the same time, forex market psychology also militates against the Lebanese pound for fear that the conflict might expand, the Hezbollah get restless and Israel compelled to intervene in Lebanon yet again.

The rest of the world may not care that the Venezuelans elected themselves a leftist President. But a successful forex investor will see the opportunity in Hugo Chavez proclaiming an embargo on crude oil exports to the U.S. and President George W. Bush wanting to make up the shortfall with Mexico. This evidently calls for taking a position on the Mexican peso and selling the Venezuelan bolivar short.

Economics, politics and market psychology comprise a host of indicators that bear watching all throughout the trading day and over the long term. At the end of the day, investing in foreign exchange rate movements is rich with opportunity precisely because of the gigantic volume, because there are dozens of currency pairs to watch and numerous developments can influence their relative value.

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