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Basics of Forex

Basics of Forex

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Published by nitin

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Published by: nitin on Dec 07, 2008
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05/09/2014

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Five Key Factors that move the ForexMarket
To profit from the fascinating world of international trade, wemust have a firm grip on the key factors that affect acurrency's value. When making our trades, we analyze fivekey factors. In order of importance, they are:
Interest Rates
Economic Growth
Geo-Politics
Trade and Capital Flows
Merger and Acquisition Activity
Key Factor 1. Interest Rates
We use two methods to profit from the difference incountries' interest rates:
interest income
capital appreciation
Generating interest income.
 
Every currency in the world comes attached with an interestrate that is set by its country’s central bank. All things beingequal, you should always
buy currencies from countrieswith high-interest rates and finance these purchaseswith currency from countries with low-interest rates.
 
For example
, as of the fall of 2006, interest rates in theUnited States stood at 5.25%, while rates in Japan were setat .25%. We could have taken advantage of this ratedifference by borrowing a large sum of Japanese yen,exchanging it for US dollars, and using the US dollars topurchase bonds or CDs at the US 5.25% rate. In otherwords, you could have borrowed money at .25%, lent it outat 5.25%, and made a 5% return. Or you could saveyourself all the hassle of becoming a money lender by simply
trading the currency pair
to affect the same transaction.
Generating income from capital appreciation.
As
a country's interest rate rises, the value of thecountry's currency also tends to rise
-- this phenomenongives you a chance to profit from your currency's increasedvalue, or capital appreciation.
 
In the case of the USD/JPY spread in 2005 and 2006, as theUS interest rates stayed higher than Japan's, the dollarcontinued to increase in value. Investors who traded yen fordollars gained from interest income as well as the US dollar'scapital appreciation.Another great example of the power of interest rates in thecurrency market occurred in August of 2006. At that time,the Bank of England surprised the market by raising itsshort-term rates from 4.5% to 4.75%. Interest rates forJapan were still at a low .25%.The rise in England's interest rates widened the interest ratedifferential on the popular GBP/JPY cross from 425 basispoints to 450 basis points. Investment money flowed intoGreat Britain as traders bought up pounds to take advantageof the new spread. As the demand for the GBP increased,the value of the GBP increased, and the spread between thecurrencies increased. This domino effect lead to a
700-point rally
in the GBP/JPY over the next three weeks.
Key Factor 2. Economic Growth.
The next factor you need to consider when predicting acountry's currency movements is its economic growth. Thestronger the economy, the greater the possibility that thecentral bank will raise its interest rates to tame the growth

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