Most traders know that forex trading online is just a part of the big financial market comprising of the stock, bond, commodity markets and their derivatives. And since today’s markets are highly integrated within each other, it is easy to assume that events in one segment of the financial market will always have repercussions and consequences in other market segments. Indeed, the forex market has an even greater role in this sense as the main medium of all international transactions. If an investor in Japan wants to purchase a U.S. Treasury bill or bond, he has to do so through the forex market, unless he is already in possession of some U.S. dollars.
In the short term, traders move money, in the long term. events move markets. What does this mean? In the short-term market events are determined by traders moving money around from one asset class to another in frantic reaction to various market events. These short-term reactions are for the most part unpredictable. In the long-term however, markets themselves are moved by events in a way to a degree that is way beyond the speculative flow of money from one place to another, as they establish long term patterns in the behavior of major actors (like banks, large firms, governments) which are then called trends. And these trends are often the most important determinants of market action.
Let’s see an example of a hypothetical scenario where a small change in U.S. interest rates has repercussions across many markets. When interest rates fall, for example, the yield (interest earned) of government bonds also falls, which leads investors to sell the currency. Since falling interest rates often signal future strength of economic activity, and consequently higher demand for commodities, some of the dollar sellers will use their funds to purchase commodities like oil, driving up their price. This, in turn, will cause the currencies of nations like Canada or Russia to appreciate, since they are oil exporters. In turn, these exporters will use their own trade surpluses to purchase assets in advanced economies like Europe or the U.S., for example, driving up stock prices.
The hypothetical scenario above should show that the degree of interconnectivity in market events is very high. Even so, due to its role as the middle market, so to speak, the forex market is perhaps the most reactive of all markets. How can we use this knowledge for practical results? First we must be more careful in adjusting leverage, because the reactive nature of the forex market makes it more volatile. Second, as traders we need to keep track of events in more than one market, because forex can be influenced by disturbances in any financial market. And finally, we can exploit periods of divergent movement in the markets for profit. For example, if the dollar rallies as interest rates fall, we can anticipate that this short-term imbalance will be corrected in the future, and sell the dollar in expectation of future gains.
In short, forex is not an independent market. It is a part of a whole that is influenced by all kinds of events in the political and economic fields. After all, that’s why we should always seek
forex brokers which offer a news stream service if we seek to make use of fundamental analysis in our decisions.
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