February 10, 2017
Deciding when to buy or sell a currency is probably the most important question in forex trading. Making this decision right or wrong will determine your success in becoming a profitable trader in the long run. In the following lines, let’s give a few examples to show you how the market should be analyzed to make a sound decision whether to buy or sell a currency pair.
Nothing moves the currency market more than the labour reports. This a leading indicator of the economy, as companies will be reluctant to add new payrolls if they think there will be no increase in demand for their goods or services in the future. Similarly, companies will hire new workforce if they assume the demand will pick-up in the near future. On the employee side, nothing deteriorates personal consumption more than becoming unemployed – and personal consumption also has the biggest share in a country’s GDP. Simply said, a falling unemployment rate gives solid indication that the economy is doing well and that future GDP may increase.
The U.S. non-farm payroll report, published on the first Friday each month, is a major report that every trader should watch. If you believe the U.S. will add more payrolls than expected, this will be bullish for the U.S. dollar. In this case, you would consider buying the USD pairs where the USD is the base currency, or selling pairs where USD is the counter currency. Both would be sound trading decisions.
Interest Rate Hikes
Central banks often hike interest rates when the economy is doing well, and to dampen inflationary pressures. A key thing to consider is whether such interest rate hikes are already anticipated by investors, and thus already priced into the market. There are many signs that hint interest rate hikes: a falling unemployment rate, a rising inflation rate above the central bank’s target, rising retail sales, growing GDP quarter over quarter, and countless others.
All these signs are bullish for the domestic currency. On top of that, an interest rate hike would attract foreign capital inside the country, which additionally spurs demand for that currency making it appreciate.If you believe the European economy is doing well, and an interest rate hike is around the corner, you would buy currency pairs where EUR is the base currency (like EUR/USD), in the expectation that EUR will rise against the U.S. dollar.
A Rising Price in Commodities
Major commodity producers tend to experience their currencies rising or falling with changes in the commodity prices. Think of the Canadian dollar, which is closely related to oil prices, or the Australian and New Zealand dollars which are linked to gold. Canada is a major exporter of oil, exporting around 2 million barrels per day to the United States. A rising oil price will be beneficial to the Canadian economy, making the CAD appreciate. You would like to sell currency pairs where CAD is not the base currency, like USD/CAD to take advantage of the rising oil prices.
Australia and New Zealand are both large exporters of gold, and rising gold prices tend to have positive impact on their currencies. You could buy currency pairs like AUD/USD or NZD/USD in this case. While the Australian and New Zealand dollars are rising, the US dollar usually falls with rising gold prices as investors sell dollars to buy the precious metal.
Trading on Margin
A margin is a part of your trading account, which is used as collateral to open much larger positions than your trading account would otherwise allow. Many traders new to the markets think about margin as a “transaction cost”, but this is far from true. A margin is just a part of your trading account which is “locked” until your position is open. The margin still belongs to you.
This table shows the required margin as part of your trading account to open positions on different leverage ratios. The higher the leverage you use, the smaller the required margin is, but keep in mind that higher leverage increases both your risk, as well as profit potential.
Rollover Interest Rates
Rollover interest rates offered by brokers are interest rates paid or earned for holding a position overnight. The current interest rates for the major currencies are presented in the following table:
If you opened a buy position on NZD/USD, you would earn a positive interest rate return equal to the difference between the NZD interest rate (bought currency) and USD interest rate (sold currency). Similarly, a short position on USD/CAD will have a negative rollover interest rate, as the Canadian dollar has a smaller interest rate return than the U.S. dollar.