What drives currency markets and what are some examples of forex trading?
In general, it can be said that liquidity and market flows dictate short-term price movements on currency markets, while economic fundamentals shape longer-term trends.
On the fundamental level, the economic data of individual countries as well as global events can have an effect on the exchange rate. These data or events include:
Unemployment data / Non-farm payrolls
Interest rate decisions
Decisions to reduce or increase central bank asset purchases
Communication by central bankers
The USD as a global reserve currency can have implications even if you trade a minor currency pair like GBP/CAD or a regional one like NOK/SEK, so it’s good to keep an eye on any clues from the greenback, as well as the euro, the common European currency. Some key events not to miss:
FOMC (Fed) meetings for US monetary policy
European Central Bank (ECB) press conferences
Meetings of the Organization of the Petroleum Exporting Countries (OPEC)
Geopolitical events that could lead to an increase in risk aversion
Let’s see an example of a currency trade!
A trader expects the British pound to lose value against the US dollar because the Bank of England might cut interest rates, while US economic data has lately been beating economic forecasts. The trader therefore decides to try to make money acting on this expectation, by selling a standard lot of GBP/USD at the current exchange rate of 1.35510. If things go as expected, the exchange rate will go up, and the deal can be closed with a profit, but if things go the other way he will lose money.
Each contract is equal to 100,000 of the base currency of the pair. In this case, selling a single GBP/USD standard lot is equivalent to trading £100,000 for $135,510.
Since forex is a leveraged product, you don’t have to put down the full value of your position upfront. If you are using 1:200 leverage, that means that instead of £100,000, you only have to put up $677.55 (£500) to complete the above transaction. Of course, we recommend having more cash in your account so a sudden blip in the “wrong direction” doesn’t stop you out automatically.
Speaking of stopping out a position, let’s say our trader has also put in a stop-loss – this means that when the exchange rate reaches a certain level, the position is automatically closed. Our trader put this stop-loss at the technical resistance level of 1.362, so that if the exchange rate moves in the opposite direction as expected, the losses are limited (“stopped”) at this point and do not potentially get out of hand.
If our imaginary trading friend managed to read the tea leaves correctly and the price of the “cable” (a nickname of the GBP/USD pair) indeed tanked after a rate cut, he managed to make a profit on the transaction.
To calculate his profit, we have to multiply the difference between the closing price and the opening price of the position by its lot size. Thus, if the position was closed at 1.3344, that would mean ($1.3551 - $1.3344) x 100,000, which means a profit of $2,110 (minus any overnight charges and commissions).
Of course, the trade could have gone the other way: it could have been stopped out at the set stop-loss level of 1.362 even before the Bank of England’s decision to cut rates (ouch), which would have resulted in a loss of $136,200 -$135,510 = $690 (plus any overnight charges and commissions).
We recommend using a demo account if you’re about to explore how to start forex trading. Using a demo account can be the best way to learn forex trading.