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The key to greater profits – Analyzing Forex Markets

The five most traded currencies in the world are US Dollars, Japanese Yen, British Pound, Swiss franc and the Euro. Country specific scenarios like unemployment, higher inflation, and political uncertainties in a country usually cause a decline in the value of the currency of that country. The US Dollars participation in more than eighty percent of world transactions makes it undoubtedly the most significant currency in forex markets.

Currency Markets

The fluctuation in the value of a currency is solely based on demand and supply parameters. For example, the more the number of transactions made with a currency, the more it becomes valuable. So a currency having less demand would devalue fast, and that would have an impact on its rate value. Of course all this depends on a country’s economic standing i.e. whether the people have the most employment, and whether there are more needs for commodities and supplies. If a currency is valuable, it definitely attracts other investors to take a chance on buying it. Therefore a powerful currency would have a consistent price rate that doesn’t devalue for a long period of time.

With the advent of globalization, currency exchanges constitute some of the biggest transactions in the world money markets. To understand the value of a home currency you would have to compare it with another currency foreign to it. For example, you could express 1 US $= 0.694 British Pound Sterling at current values.

One way of understanding forex markets better is by comparing it with the stock markets. Just as you would buy stocks of different companies in the stock market and make a profit when the prices rise, in forex markets the only difference is that you buy currencies and book a profit when the currency becomes more valuable. You could become a small investor in the forex market with a capital as little as $300 or invest big, because there are a wide variety of forex brokers to cater to all your needs.

There are many kinds of trading methods that will help you analyze current market conditions so that you could predict future trends. To be successful, you have to predict the trends before it occurs, so you could buy currencies and sell them when the prices rise. In some cases, it would mean buying a currency that was dropping in value and then profit from the currency when it takes an upward trend. What does all this mean? It simply means you have to always keep abreast of what is happening in forex markets, by analyzing the markets thoroughly.

As explained in earlier articles, there are two ways to analyze forex markets in terms of trends and make a prognosis on future opportunities. These methods are known as technical analysis and fundamental analysis.
A person using fundamental analysis would look at the current economic climate, political events and a variety of economic indicators to try and predict currency moves. Generally it is the large institutional players who look to fundamentals for predicting price moves. As a day trader you should be looking at technical analysis more. However technical analysis which uses historical price patterns in economic data to predict future moves takes into reckoning three major assumptions.
They are:

  1. The fact that all market forces are taken into account in price movement. In other words, technical analysis does not take into account economic conditions, because it presumes that the market has already accounted for that.
  2. It presumes that currency price movements form market patterns that follow predictable paths.
  3. It further presumes that there are historical trends in price movements. What this means is that, when circumstances are similar the same pattern would likely be repeated.

Is technical analysis necessary?

Yes for a day trader it is very important provided he learns to supplement it with fundamental analysis. The greatest advantage of technical analysis is, it could be used for a wide range of currencies and markets in different parts of the globe almost simultaneously. Although it may look complicated to a beginner, technical analysis is a very important tool for the day trader.

How does technical analysis go about doing what it does?

Technical analysis goes about its business by interpreting charts that are constantly updated in real time and could be viewed in different ways—as for example, you could see in the charts price movements over certain periods in time, interfaced with analytical features that help you predict future trends. Most often the charts are to be found in the broker’s trading platform. Truly there is no substitute for charts in forex trading.

Conclusion

Of late forex markets have shown a lot of volatility, mainly due to the crunch in liquidity across other financial markets in recent times. This volatility may continue to cause extreme price moves in coming days. Since available liquidity at any price is now worse than in normal market conditions, forex traders should take care not to risk too much. This is also indicated by the bid/ask spread widening across most traded instruments in financial markets.

However at the moment, the increasingly liquid forex markets have sufficiently coped with the fallout from broader financial instability. This is evidenced by the fact that key forex bid/ask spreads remain only slightly above their typical levels. Widened spreads only suggest that banks are unwilling to take risks beyond a point, but it doesn’t seem so acute in forex markets at the moment.
Nevertheless this perceived systemic risk has forced major institutional investors to limit their exposure to currency trading, but the situation is certainly improving for the better.

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