Currency trading involves many basic concepts. These include volatility and liquidity. Liquidity does refer to the number of buys and sells in the market. Volatility refers to the deviation of rates from their base value, which can be a source of opportunity and risk at the same time. Listed below are some basic concepts that everyone should know. To make sense of them, understand the terminology and learn about the trading strategies.
Fundamental Analysis
The fundamental analysis of forex involves examining external factors that can impact the value of a market. Global interdependence has made various asset classes more interconnected than ever before. Large economic reports can have wide-ranging implications, even if they do not have an immediate impact. Understanding the underlying economic trends in a currency pair can help you predict future price movements and make the most informed decisions about trades.
A major difference between the stock market and the forex market is the type of fundamental analysis used. Fundamental analysis of forex is closely tied to the economy of a country. It considers factors such as unemployment rates, fiscal policy, political unrest, and other economic data. For example, a stronger economy in the United Kingdom might result in the Bank of England raising interest rates. As a result, currency values may go up or down.
Technical Analysis
The most important principle of technical analysis is that prices tend to repeat themselves. Price patterns, also known as support and resistance levels, can be used to spot a potential reversal area. A trendline is a line connecting significant highs and lows. These patterns are known as descending resistance. There are several different types of support and resistance trendlines. To determine which type of trendline to use, you should be able to find several patterns.
The main goal of technical analysis is to profit from previous price patterns. The tools used to perform this analysis include charting and analyzing price and volume. Traders can also use indicators such as implied volatility, supply and demand, and moving averages. Price trends show the general direction of a stock or currency pair. This trend can be identified by examining the peaks and troughs of the graph, which move steadily.
Short-Term Spreads
While you don’t need to become a currency trader to take advantage of short-term spreads, it is important to understand them. Short-term spreads on the forex market involve currency pairings. These are often presented as two numbers side-by-side. They are very confusing without the proper knowledge of the currency pairs, but a bit of quick mental math will help you decipher the data and determine what you can invest.
The spread is the difference between two prices. The spread is how much the broker makes by offering the two currencies at different prices. For example, let’s assume you want to buy EUR/USD at 1.2000. Your broker will quote you two prices – the asking price and the bid price. If you want to purchase EUR/USD at 1.2002, you will pay your broker two pips in spread to buy it.
Currency Arbitrage
In the foreign currency market, one of the basic concepts that everyone should understand is currency arbitrage. This technique is about capitalizing on the difference in buying and selling prices. In this example, let’s assume that the exchange rate of the euro/dollar at Bank A is $1.25. The investor can choose to convert the euro to dollars at Bank A and then trade the dollars for euros at Bank B. The difference in prices is called the difference in price discovery.
The reason why price differences between two markets exist is because of market inefficiency. According to the Efficient Market Hypothesis, which was developed by economist Eugene Fama, all active traders will process price information and bring the market back to equilibrium. In such a landscape, there would be no room for price discrepancies between the two markets. This is why arbitrage opportunities arise.