Before you start trading on the foreign exchange it is important that you understand the concepts of the forex market. There are 5 primary foreign exchange concepts that you have to know about. When you know about these concepts you can determine how they affect your trading and what you can do to limit
The Factors that Shape the Foreign Exchange
When you trade forex you have to know what shapes the forex prices. When you understand these factors you will be able to analyse the market and make informed decisions about where the market is heading. Most traders use technical analysis to determine the movement of the market, but there are traders that rely mainly on the fundamental analysis of the market. Technical analysis uses charts to analyse what has happened in the market and determine what will happen. Fundamental analysis uses economic and political news to determine what the market reaction will be.
Using the Major Currencies to Trade
While the forex market does include every currency there are 8 major currencies that you should look at. These currencies are the most volatile and liquid in the market making them easy to use for new traders and most trading strategies. These currencies also have the largest financial markets which makes getting information about them very easy for the retail trader. New traders should focus on these currencies when they start trading. Once more experience has been gained it is possible to look at emerging currencies and exotic pairs.
Knowing about Yield and Return
When you trade on the forex market you are buying one currency and selling another. The return you get on any trade is related to how the one currency moves against the other. You also have to consider the interest rate of the currency’s country. When one currency has a higher interest rate then the other you may receive or pay rollover interest. This interest is calculated at 5pm EST each day. If you are holding the currency with the high interest rate then you receive the rollover interest, but if you are selling it then you have to pay the interest.
Understand what Carry Trading is
Carry trades are related to the yield and return of high interest and low interest currency pairs. The rollover interest is actually the basis of the carry trade. Trades using this strategy will open positions with currency pairs where they receive rollover interest. These traders will keep the position open for as long as possible to continue to receive the interest. Many traders actually make the majority of their profits with these trades as the pair does not have to move for you to make a profit.
The Pros and Cons of Leverage
The forex market offers much higher leverage than any other financial market. There are some forex brokers that offer up to 400:1 leverage. The use of leverage can increase the returns you make as it increases the amount of buying power you have. Most experienced traders state that 10:1 leverage is more than enough for most trades. Using leverage about this point can be too risky as you increase the amount of your account balance you risk.