People trade foreign currencies to two distinctly different reasons. First of all, companies that buy products from foreigners pay with foreign currencies. They trade foreign currencies to make payment and often buy currency options to hedge currency risk. These traders limit themselves to the currencies involved, their own and that of the company from whom they are going to purchase a foreign product. On the other hand currency speculators trade foreign currencies for profit. They pick and choose currency pairs to trade based on market volatility and their analysis of fundamental and technical factors. In each case success comes from careful analysis and timely execution of trades.
Hedging Risk in International Business
Forex trading and currency risk are inextricably intertwined. Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. The basic need for a Forex market comes from the need to do business across national boundaries. A translation risk is the risk that the Forex market rates will change between writing a contract and final payment. A Chinese ship building company writes a contract for payment in dollars for building a ship. Then the company buys what it needs to build the ship and it pays its workers in Yuan. The value of the Yuan goes up and the dollar goes down. The company ends up losing money on the sale. An American high tech company agrees to pay a German company in Euros for each dosage for use of its patent on a genetically engineered cancer therapy. The Euro goes up and dollar goes down. The American company’s payment in dollars by the HMO’s and Medicare is frozen and the company cannot afford to make and sell the drug in question. Companies commonly buy currency options in order to set a price that they will pay no matter how much the relative value of a currency pair changes.
Picking the Most Profitable Currency Pair
Currency speculators are not tied to a given currency pair. They will scout out market volatility, analyze fundamentals and track market sentiment with technical indicators. Then they will place timely trades in order to profit from the inefficiency of a moving market. The point of speculating is not to hedge risk but rather to make money trading currencies. Technical analysis tools such as Japanese Candlesticks help traders anticipate price fluctuations based on changes in market sentiment. Sound fundamental analysis tells a trader where the market will eventually end up so that he can place his trade and simply wait for the market to come to him. As with all business, showing up every day and learning the appropriate skill sets are what lead to success. And, as always, do not trade when you are too tired to think. Check out every tip that you receive. And when you trade currencies stay out of any and all trades that you do not understand.