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There's Money In Money

Every day, US$6.6 trillion is traded on foreign exchange markets. Do you want a piece of that? Chris Smith of CMC Markets shares his top insights on trading the currency markets.

5 October 2021

Learning to trade forex is no simple task, which is why so many people suggest you should leave it to the professionals who dedicate their lives to following its fluctuations.

Even the most experienced of traders can struggle to consistently predict how exchange rates will go up and down. And economists can’t always forecast the economic performance of countries over
the short and medium term.

But new technologies mean you no longer need an office on Wall Street, in Frankfurt, or in London to be a foreign exchange trader – so anyone with reasonable capital and investment experience can trade foreign exchange.

Automated forex trading systems create strategies for the technically-minded, and help overcome the handicap of having limited time to manage trades.

It can be an uphill battle for your average trader, compared to someone on the trading floor at a big bank.

Your success largely depends on your timeframes, how determined you are, and your risk tolerance – although many people would say the same thing about the share markets or the commodity markets.

Why trade foreign exchange?

Forex trading has a number of advantages.

It challenges the mind and makes you think globally and about the world’s economic dynamics, while still providing an ample risk and reward opportunity.

Here are 10 reasons to consider forex over other markets.

  1. There’s a huge amount of free information available to use to educate yourself.
  2. Automated trading systems are available and can be back-tested.
  3. You can trade any timeframe you like. Strategies can be short term, medium or long term.
  4. There’s a high level of ‘liquidity’, which means you can easily enter and exit, which is important in any investment.
  5. You can hedge your exposure to risk, and maximise exposure to international investments.
  6. You can customise lot sizes and trade smaller lot sizes to reduces your risk while you’re learning.
  7. There’s no commission, so every profit or loss is cleanly accounted for.
  8. You can apply strategies across many currency pairs – trend-following.
  9. Forex markets are open 24 hours a day, five days a week, so you can get in or out of a currency any time you want.
  10. You can apply technical analysis or be a purely fundamental analyst.

How are you with risk?

As one of the most accessible markets to take part in, forex is comparable to shares, but you need a different risk tolerance.

In recent times, we’ve seen some wild movements in major currencies, with Brexit, central bank quantitative easing programmes pretty much printing money, and negative interest rates causing big adjustments to currency values, all in quick succession.

These fluctuations can lead to big wins – and big losses.

Lots of choice

There are more than 170 major, minor and ‘exotic’ currencies in the global forex market.

Traders can choose from a diverse range of currency pair options, but it’s the seven major forex pairs that make up 68 per cent of global foreign exchange transactions.

The most frequently traded currency pairs and their share of the forex turnover among Kiwi traders are:

  • EUR-USD: Euro-US dollar (24%)
  • USD-JPY: US dollar-Japanese yen (18%)
  • GBP-USD British pound-US dollar (9%)
  • AUD-USD Australian dollar-US dollar (5%)

In the last Bank of International Settlements (BIS) survey on daily turnover by currency pair, the New Zealand dollar against the United States appeared in 12th place, ahead of the Mexican peso and behind the Singapore dollar.

Overall, the New Zealand dollar usually sits in 10th place for currency transactions.

After Covid-19, central bank stimulus measures like reducing interest rates towards zero, or to negative rates in some countries, have reduced volatility in forex markets and seen a shift to equity market traders, futures and options.

This is positive for businesses and consumers, who like stability, but not so interesting for traders looking to trade the trend.

Traders used to be able to focus on every rate decision by the Fed (Federal Reserve) and the Reserve Bank of New Zealand and see 1 per cent-plus movements in exchange rates.

Cryptocurrency enters

Forex volatility is a lot lower than you’d see in crypto trading, which is booming globally for speculators, as a new type of currency to trade.

Crypto is a difficult currency to use for transactions of goods and services, but many holders simply see it as a store of value, rather than the medium of exchange they once predicted it would be.

The release of the first decentralised cryptocurrency, Bitcoin, in 2009 was a pivotal moment, and we’re now seeing it used in more diversified portfolios.

Since Bitcoin was developed, more than 6,000 other cryptocurrencies have been created, usually traded against the US dollar, Euro, British pound or Australian dollar.

These currencies can’t all possibly win the race, so I’d urge caution. Taking the mantle of reserve currency from the mighty US dollar won’t happen in our lifetime.

What’s ahead

As global central bankers try to move into a tightening framework post-Covid recovery, although at a snail’s pace, raising rates and battling with inflation data targets, it’s likely forex markets will be more volatile, after a longer period of low volatility.

Our Reserve Bank is sounding the most hawkish, having jumped to the front of the queue of central banks by adjusting monetary policy, with the end of its long-term asset purchases.

When New Zealand starts to raise interest rates, we can expect adjustments to New Zealand dollar values for exporters and importers, and plenty of trading opportunities.

At the time of writing, we’re already seeing some backtracking in expectations across the Tasman, as Australia battles another lockdown and its impact on the economy.

Traders will be closely watching to predict the pace at which rates will be lifted over the next three to five years, to return to some sort of normality.

The ‘wall of worry’

In the short term, there’s no shortage of factors contributing to a ‘wall of worry’ for forex traders, as many complex forces play out in the global economy:

  • The Delta surge of Covid-19.
  • The Federal Reserve being potentially behind the curve on inflation and rates.
  • Valuations hitting record levels on many asset classes, like shares and property.
  • Recovery and reopening stuck in stop-start cycles.
  • High unemployment rates.

There are all these negative factors at play, and markets always climb a wall of worry.

If you stay informed and these things fascinate you, forex could be the perfect place to put your research and forecasts to work.

Disclaimer: Cryptos carry a higher risk than forex. CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The author does own shares in some of the securities mentioned.

Informed Investor's content comes from sources that Informed Investor magazine considers accurate, but we do not guarantee its accuracy. Charts in Informed Investor are visually indicative, not exact. The content of Informed Investor is intended as general information only, and you use it at your own risk.

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