The Foreign Exchange Market

The foreign exchange market (Forex) is used to convert currency from one country into the currency of another. It allows individuals and companies from different countries to easily sell products.

Every country has its own currency.

The common Forex Currencies are:
U.S. Dollar($)
Euro(€)
Australian Dollar(A$)
Swiss Frank(CHF)
Japanese Yen(¥)

If a business exports something to another country they use the Foreign Exchange Market to convert payment.

How does an individual profit in forex?

The currency prices on the Forex market fluctuate due local, global, and economic factors. This gives the individual forex trader the opportunity to make a profit using arbitrage. Arbitrage is the buying of a currency at a low price and selling it at a higher price.

Ex.
($)= US Dollars (¥)=Yen
$1=¥130

I use $10,000 to buy ¥1,300,000

The value of the ¥ rises therefore it takes less ¥ to buy dollars.

$1=¥100

I use my ¥1,300,000 to buy $13,000 and make a profit of $3,000.

How are Forex rates determined?

Foreign exchange rates are determined in two ways.

Long Term

Foreign exchange rates are determined by the supply and demand of the money supply.
A country’s money supply is regulated by the government and its central bank. When the government wants to increase the money supply, it tells the central bank to print more money or lower the interest rates.

Ex.

The U.S. Government increased the nation’s money supply when they bailed out the failing US Banks in October of 2008. This caused the supply of the $ to increase, therefore lowering the demand and decreasing the price.

http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=airpxcdYO32M

A country’s money supply has little to do with short term Forex rate fluctuations.

Short-Term Investor Psychology

When investors act on expectations of the price of a currency it causes a bandwagon effect. This causes the price of the currency to fall or rise in the short term.

Ex.
A major hedge fund manage states the US Dollar is undervalued. The price of the US dollar rises regardless of the statements truth because the individuals act on this managers advice.

How do I predict Forex exchange rates?

There are two styles of analysis.

Fundamental Analysis

Fundamental Forex analysis uses the size of the money supply, interest rates, and inflation rates. It may also use a countries balance of payments (imports vs exports).

Technical Analysis

Technical analysis relies on analyzing past trends using price and volume data to predict future trends.