Forex trading is growing in popularity around the world. More and more people are realizing the benefits of what is known as forex trading. But the question is how do these currency transactions affect the economy?
Forex Trading Defined
Forex trading refers to the buying and selling of foreign exchange. The foreign currency can be exchanged for your own currency, but also for a foreign currency. Trading takes place via electronic platforms or by telephone. Forex brokers allow you to trade online through their trading platforms. Read more about the best forex brokers on Digicoin Center feature.
In the event of currency fluctuations, profits can arise for the trader due to differences in the exchange rate. An example: a rising exchange rate of the euro is foreseeable. Then a trader buys euros in exchange for US dollars, for example at an entry rate of 1.089. The rate now rises to 1.100 the trader can sell his euros profitably and pocket the difference as profit.
What does the exchange rate of a currency depend on?
The value of a currency is always closely related to the economic performance of a country. There are a number of indicators that can show the price development of a currency. The most important indicators that beginners should definitely pay attention to are the following:
- Employment data
- Economic data
- Publications by central banks and other financial institutions
How does forex trading make an impact on the economy?
Not only does a country’s economy affect forex trading, but vice versa, forex trading also affects the economy. The two issues are closely intertwined and cannot be viewed separately. The complex relationship between the economy and currency rates can be illustrated using a simple example: if the US dollar rate rises, this necessarily means that the euro rate will fall (relatively). Then it will not only be cheaper for Americans to buy euros, but all products from the euro area will also be cheaper. Many people know this effect of exchange rate fluctuations from vacation: if the euro is strong, tourists can exchange it for another currency and look forward to more purchasing power than when the euro is weak.
So is it bad for the economy if the exchange rate falls?
It depends! A falling exchange rate is of course a disadvantage for tourists: they then receive less and less foreign currency for the same amount in euros. Companies that export many products is a declining but beneficial. If the exchange rate of the euro falls, German products become cheaper on the US market, for example. This in turn means that German products have a price advantage on the American market. China, for example, is often accused of keeping the rate of the Chinese currency, the renminbi, artificially low. Why? Because Chinese products can then be bought cheaper worldwide. Germany also benefits from this effect. The German economy, which is very strong in a European comparison, is benefiting from the comparatively low value of the euro.
Why is risk diversification of the investment portfolio important in currency trading?
Anticipating exchange rate developments of a currency is not so easy and even experienced experts find it difficult to make reliable predictions. Therefore, it is always recommended not just to rely on one course, but to spread the risk by dividing investments into a larger portfolio of currencies. Particularly with long-term investments, there is always the risk of unexpected crises that no indicator can capture. Terrorist attacks and natural disasters usually come unexpectedly and can have a significant impact on a currency’s price. To reduce the risk of such events affecting the overall investment, risk should be spread. In the case of very short-term transactions, it can sometimes be an advantage to rely on just one course, but this is really only very rarely the case.