The foreign exchange market, which is also known as the forex market, is a global financial market in which participants speculate on the direction of a currency pair. Investors who attempt to make money trading the forex markets generally use either fundamental analysis or technical analysis to determine the future direction of a currency pair.
The forex market trades 24 hours a day, six days a week, across every time zone. The securities that are used to trade the forex markets are currency pairs. A currency pair is the relative relationship between the currencies of two countries. For example, the USD/JPY currency pair is the relationship between the U.S. dollar and the Japanese yen. This currency pair is quoted in yen per dollar, and moves higher as the dollar becomes stronger versus the yen.
Investors can use a number of techniques to determine the future direction of a currency pair. One of the more popular techniques is fundamental analysis, which involves studying the monetary policy of each currency and the economic data that reflects a country's economic growth. Robust economic releases reflect an economy that is growing, which in turn creates increasing interest rates, making the country's currency strong. Soft economic releases usually coincide with decreasing interest rates, which in turn create a weak currency. For example, a stronger-than-expected gross domestic product release in the United State would generate an increase in demand for U.S. dollars.
Many investors believe that all the information that is currently available about a currency pair is already incorporated into the price. With this in mind, many investors follow historical price action to determine the future movements of a currency pair. Technical analysis ranges from using specific patterns to determine future price action to studying momentum and moving averages to detect the direction of a trend. For example, when a short-term moving average of a currency pair exceeds a long-term moving average of a currency pair, the currency pair is said to be in an uptrend.
Many forex brokers offer significant leverage, which assists in generating higher returns. Leverage can also work against an investor, as losses can pile up quickly. Leverage can be offered as high as 100 to 1, which means that $100 dollars can be borrowed for every $1 used to transact a currency trade. Investors should use strong risk management techniques to ensure capital preservation.
David Becker is a finance writer and consultant in Great Neck, N.Y. With more than 20 years of experience in trading, he runs a consulting business that focuses on energy hedging and capital market analysis. Becker holds a B.A. in economics.