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How to invest in the Forex Market: 5 things you need to know
4 minute read
Economists forecast a looming global recession sometime in 2020. With international uncertainties rising from trade wars and Brexit negotiations in the UK, investors are increasingly turning to more liquid markets to mitigate risk. Forex is the most liquid market in the world and like gold and other precious metals, and knowing how to invest in the forex market is important for investors when volatile economic events are predicted.
Trading Forex involves profiting from the movement of relative values of a currency pair. Investors turn a profit in Forex markets by buying currencies low and selling them high. Unlike stocks and bonds markets, it’s a 24-hour investment market.
So, if you’re looking at jumping into the Forex market, here are some things you need to know:
The Australian dollar
The Australian dollar has had its fair share of highs and lows this year, as it has been impacted by the current global turmoil. This presents unique opportunities for Forex traders, as Australia is the world’s 13th biggest economy and has large mining and commodity production industries.
However, its foreign commodity trade is highly sensitive to China’s international trade patterns. As the Yuan is a floating currency, any changes in trade and tariffs directly affect the Australian dollar. In fact, the recent escalating spates of tariff increases between China and the US have led to trade deficits and the contraction of the Australian dollar.
The biggest factor in the Forex market is the movement of interest rates in global central banks. This indicates how much you profit from holding onto a position, as higher rates yield higher profits. As central banks base these on a host of factors including public spending, CPI, and housing markets, big announcements affect the Forex market.
Last month, the Reserve Bank of Australia cut its key cash rate to an all-time low of 0.75%. Around 40% of central banks have already cut rates, including the US Federal Reserve. This has shorted the Australian dollar for a long time, which in turn has made it more attractive to Forex buyers.
The Australian Securities and Investments Commission (ASIC), which regulate financial services including Forex trading, is a relatively conservative institution. This has provided long-term stability in Australian Forex markets. But following some incidents, it has increasingly enforced stricter rules. This is why when choosing brokers, check for accreditation and track records.
One of the cases it has taken this year includes a lawsuit against five big banks colluding on Forex strategies. Bloomberg reports that ASIC recently filed a class action suit against Citigroup, the Royal Bank of Scotland, JP Morgan Chase, UBS, and Barclays. The banks are now facing accusations of manipulating Australian Forex trades through reducing the value of Australian investors and businesses.
Leveraging in Australian Forex
Leveraging is a key strategy in Forex trading. It allows traders to invest only a fraction of their lot value. This means you can make a huge amount of money from a small starting investment. But it also means heightened risk as you may lose more than what you invested in the process.
Finance Feed cited a study on Forex laws, that looked at how different traders traded using a leverage. There has long been a debate on how to regulate leveraging to protect investors more from unnecessary high-risk trading. The research found that Australian brokers, when leveraging, improved the market's quality and were not speculative. However, the study also showed how leveraging can amplify an investor’s losses if they weren't careful. This is why FXCM advises that beginners start with lower leverage ratios until they feel comfortable in the market. A good rule of thumb is to not exceed a leverage ratio you can’t pay if you lose.
Picking a strategy
In addition, Forex strategies are critical in navigating the market. Long-term strategies involve holding a position and looking at macroeconomic indicators to signal buying or shorting. On the other hand, day trading profits from smaller and incremental changes in currency pair values. It involves technical analysis on market movements in the economies. With leveraging, short-term strategies’ of small changes can turn into big profits.
A strategy that’s more unique to the Australian dollar is carry trading. This strategy involves buying pairs like the Japanese yen/Australian dollar with high interest rate spreads. As long as the exchange rate between the two does not change, investors can make a profit. While the conservative fiscal environment in Australia in the past has made carry trading popular, recent interest rate cuts have made this a risky strategy.
While currency rates are especially hard to predict and navigate, economic trends condition long-term currency movements. As Australia has a fairly wealthy economy and high regional status, its currency will remain a top draw for Forex investors.