My New-Found Knowledge of Forex Trading

Remember my post on how I got introduced to forex trading last month. Since then I have been reading a lot about Forex and just recently took a webinar training by a forex guru based in the US. And now I can say I understand the basics of forex trading. And it is not as complicated as some people make it.

image: tradefxplus.com

Forex is simply what the Mallams at Broad street, Eko Hotel, Federal Palace Hotel and non-Mallams at Airport Hotel do. They buy and sell dollars, euros, pounds and naira. They will buy dollar from you at 177 naira and sell that same dollar to someone else for 180 naira. They make their money from the difference in the price they buy (bid price) and the price they sell at (ask price). This difference is called the spread. Then, the Mallam can decide to not sell any dollar today because he has heard that the dollar is rising swiftly against the niara. So he holds on to the dollar till the next day or two days after, when dollar is trading at a much higher rate to the naira. He makes a profit if truly the dollar rises as he expected or he makes a loss if he predicted wrongly.

You, as an online forex trader, will mostly do one of what the mallam does: you will buy and sell based on expectations of exchange rate movement rather than the spread. It's your online broker who will make money from the difference between the bid and the ask (the spread). And this is where everything can become complex. How can you correctly predict the exchange rate movement?

To answer that question, there are two types of online forex traders. The one who relies on technical signals and the one who relies on fundamental analysis. The technical signals guy uses complex calculations like the Fibonacci sequence and software tools to determine when to buy and when to sell. He pays no attention to the underlying economic principles that explain why a country's currency will fall or rise in value against another country's currency.  But the fundamental analysis guy is someone, like me, who cares very little about signals and the candlestick shapes, he pays all his attention to the macro-economics of the countries he is trading their currency and make theory backed decisions.

To supplement my indepth reading of The Economist news magazine. I have a daily google alert for all the currencies I trade, I also have a Flipboard channel for them and I daily read The Economist Expresso. I only trade when I am sure that I know what the fundamentals are saying about the movement of a currency pair. 

For example, the Japanese government recently did a massive round of quantitative easing. They went on a bond-buying spree to artificially pump more money into the economy. And by economic principles this should lead to inflation and lower value of the Japanese yen compared to the currency of another country that hasn't made any drastic monetary policy. So on the news of this, I bought the USD/Yen pair. As expected, the dollar rose against the Yen so much that the Finance minister of Japan had to comment that the fall in the Yen was more than expected. I made money. (Though small because I put in a small amount in my Forex account, but big percentage-wise).

Again, from following the news of Euro economy and the reluctance of the ECB to do the obvious. Last week, upon the news of how the Euro economy is faring I was sure the dollar would rise against the Euro. I immediately sold the Euro/USD pair. At first, the market went against me but I didn't care. My fundamental analysis was spotless, and so I held on. After about 4 days, the market began moving in the direction I predicted and I have another nice profit from that transaction. 

I also bought the EUR/Yen pair. Currently the market is against me on it. But I know that it will have to someday move in the direction I predicted. The Japanese economy is experiencing a recession. The Euro currency economy is growing and slightly better than expected. Following the fundamentals, until the ECB does a quantitative easing, the Yen will not permanently rise against the Euro and should fall over time.

Finally, as sound as my explanations sound. Economics is like a Y-shaped fork. It always leads to more than one possible outcome, sometimes opposite outcomes. Just like the Japanese quantitative easing led to recession instead of economic boom while it led to economic boom in the US. That's why it is said that you can lay all the economists in the world end to end and they still wouldn't reach a conclusion. Due to my unprofessional knowledge of international economics, even my analysis can be incorrect. Then when they are correct, they may still not lead to the expected outcome. But in everything, having a consistent strategy matters more than being error-proof. I can't be oscillating between technical analysis and fundamental analysis. I stick to one. And more importantly, I trade with the money I can afford to lose. And be always on top of the global finance news.