The foreign exchange market also called the forex market represents the largest and most decentralized market in the world in which currencies are traded.
In terms of size the forex market has a net trading volume of over five trillion us dollars.
Decentralized as used in describing the forex market means there is no centralized institution in control, rather the forex market is comprised of entities such as the electronic bank networks, individual traders, brokers, etc. Each entity is responsible for their trading decisions.
In the forex market the exchange activity done by the participating entities is simply initiated by placing a buy or sell order with other parties on any security.
In the forex market, trading are based on speculations of the trends of currency pairs. The speculations are often guided by forex analysis. Traders may rely on News updates or on indicators or on both indicators and the News to guide their trading activity.
While the forex market is most profitable of all markets in the world considering leverage offers and volumes traded, it is one of the riskiest of all markets due to the uneasy predictability of market.
SOME FACTORS AFFECTING THE EXCHANGE RATE OF CURRENCY PAIRS
The changes in price of a security occur, sometimes very rapidly leading to slippages.
We will be looking at some major factors that influence price movement which include; the purchasing power parity, gross domestic product, politics and the news.
Notable events occurring in a country like natural disasters, political instability for whatever reason including transition of power after an electoral results have been declared and wars can greatly affect the exchange rates.
Some of the factors above can be unexpected as well as the response of the exchange rates. This means that the rate could move in an opposite direction for some time before starting a trend that corresponds with the news.
Natural disasters, political instability and wars harm infrastructures which in turn would have a negative effect on a country’s currency value.
Instability in government could result in a mass displacement of investors from a Country which could result in the devaluation of a country’s currency value. The notable causes of political instability are in the transition of power and violent protest against a government, which could result in an insurgency in that country.
The Gross Domestic Product (GDP)
The Gross Domestic Product is the sum of the goods and services produced within a country over a period of one year.
The gross domestic product can be calculated considering the investment expenditure, government spending or purchase of goods and services and trade balance (export – import).
As a result of differences in wage and distortion in a exchange rate you cannot precisely compare economies based on their GDP. Assuming a single commodity is traded within the border of the United States and Mexico distinctively, and that commodity was sold for 1000usd in the united states and 600usd in Mexico, the retail of 20,000 pieces of that commodity within the United States would have a greater contribution to the gross domestic product of the United states than it would to that of Mexico.
In practice, the gross domestic product is taken into consideration with the inflation data. Financial markets are rather interested in the comparison of the quarterly and yearly relative changes of the gross domestic product of a country to the previous figures.
A currency tends to appreciate in value when there is significant increase in GDP of a country in relation to the inflation. However, GDP does not directly affect the exchange rates but its indirect impact is too significant to be ignored.
Purchasing Power Parity (PPP)
The Purchasing Power Parity focuses on the equalization of price levels between countries by the adjustment of exchange rates. For instance, if a commodity was sold for 30 pounds in the UK and 90 dollars in the United States, you would expect the equilibrium exchange rate to be 3USD/GBP.
The Purchasing Power Parity is aimed at establishing an equilibrium price level by the adjustment in exchange rates which is made in relation to the prices of goods and services traded in two countries. If the overall cost of goods and services measured based on the individual currencies is lower, let’s say the Eurozone and higher in the United states, the value of the Euro will outweigh that of the US Dollar in a manner that indicates an equilibrium price level in the exchange rate.
Traders often rely on either or both types analysis to guide them when they make their buy and sell decisions. Some traders believe that past price patterns of currency pairs can be used to predict future price trends and they are the Technical Analysts.
The two types of forex analysis are the fundamental and technical analysis.
The fundamental analysis involves the prediction of price movement or price trend based on political, economic and financial reports while the technical analysis is the prediction of price trend by the observation and study of previous patterns and changes in price movements on currency charts.
Fundamental analysts postulate that changes in price are as a result of external factors or events occurring outside the currency market. They take into consideration the Producer Price Index (PPI), Consumer Price Index (CPI) and other economic data to predict the price trend of currency pairs, as well as relate the uptrends and downtrends of currency pairs to the economic, financial and political reports.
While a technical analyst applies the understanding of patterns in price movement to identify support and resistance levels as well as overbought and oversold levels, to a fundamental analyst, the application of the understanding in economic and financial data reports is needed to effectively predict future price trends.
Another notable difference between these two types of analysis in forex is the time period typically adopted. A fundamental analyst focuses on longer time interval than a technical analyst ranging from weeks to even years while in technical analysis, the analyst is focused on extremely short time intervals from days to even minutes.
A technical analyst applies technical indicators like the Commodity Channel Index (CCI), Support and Resistance, Bulls and Bears, Fractals, Moving Average Convergence and Divergence (MACD), Simple Moving Average, Exponential Moving Average, etc.
To a fundamental analyst, fundamental indicators from economical and financial data reports are rather considered. Both strategies and types of analysis can be very resourceful and profitable when rightly combined.
Leverage in Forex
Leverage is simply the amount of money a trader must deposit to a broker in order to have control over a significantly larger amount.
With high leverage, profits can be multiplied easily as it enables traders to control volumes of up to ten times the size of their account.
Forex trading provides Leverage expressed in ratios. Example, 1:1000, 1:500, 1:400, 1:200, 1:100, 1:50 and 1:25.
Relationship Between Leverage and Margin
The fund deposited or held in other to keep a position open is called the used margin while the usable available margin is called the free margin.
The leverage 1:1000 simply represents deposit to volume ratio. This means that 1 unit of base currency is required to control 1000 units of base currency. For dollar forex account trading the following currencies pairs; EUR/USD, GBP/USD, AUD/USD, CAD/USD and NZD/USD.
The account leverage can be determined using the method below;
(Position size*ask or bid price)/(used margin)=leverage
This means that if a trader places a buy order with a position size of one lot on the GBP/USD pair having an ask price of 1.3259, and the brokers holds 132.59 from the traders account to keep the position open, to determine the leverage we have to use the method below.
Therefore the leverage is 1:1000.
To determine the used margin you have to make the used margin the subject of formula of the equation.
Example; (Position size*ask or bid price)/leverage=used margin
Substituting values; (100,000*1.3259)/1000=132.59
Proper leverage and margin management applied to accurate forex analysis is the key to saving your capital and making profits.
Lots in Forex
In the forex market, currencies are traded in volumes called lots .
There are basically three types of Lots in forex and they include; the standard lot, the mini lot and the micro lot.
A standard lot is equivalent to 100,000 units of the base currency in the currency pair that is traded. If a trader buys one lot by placing a buy order on the EUR/GBP pair, he trades 100,000 units of the Euro. The standard lot is greater than the mini lot and micro lot.
The mini lot represents 10,000 units of the base currency in the pair that is traded. If a trader buys one mini lot by placing a buy order on the EUR/GBP pair, he trades 10,000 units of the Euro. The mini lot is smaller than the standard lot and larger than the micro lot.
A micro lot represents 1000 units of base currency in a traded currency pair. If a trader buys one micro lot by placing a buy order on EUR/GBP pair, he buys 1000 of the Euro in that pair. The micro lot is the smallest of the standard and mini lots.
PIP (Price Interest Point or Percentage in Point) is the numerical price difference between the bid and ask price of a currency pair that is traded.Example:
The number of pips in EUR/USD with price quote 1.2730/1.1734 is 4.
If the ask price increases to 1.1744, in favor of an open position the number of pips gained is 10.
The PIP value, is positive if a trend is in favor of an open position and a negative if a trend is against an open position. The difference between pip and spread is that a spread is the amount of pips a broker charges a trader for an exchange or trade.
The lot size affects the PIP value directly which means increase in lot size results in increase in PIP value and vice versa.