Forex Trading has become extremely popular these days. Unfortunately most Forex traders have no idea what forex trading is all about. So let me explain.

Why do currencies move?

You need to understand that Forex Trading is all about interest rates. If you are trading the EUR-USD, then you are BUYING the Euro currency and SELLING the US Dollar. In Forex trading, accounts are settled every day at 5:00pm ET, and at this time you EARN interest rates on the currency that you bought and PAY interest rates on the currency that you sold.

Let me give you an example:

Currently the ECB has set the interest rates at 4.25% while the FOMC offers only 2%. If you long EUR-USD and you hold it overnight , then you RECEIVE the equivalent of 4.25% divided by 360 days for the Euros that you own and you PAY the equivalent of 2% divided by 360 days for the US Dollars that you sold. So you are receiving the equivalent of 2.25% divided by 360 days every day that you hold this position.

Note: Your broker will charge you the spread for "swapping" your position overnight, but if he is a reputable broker, then he will pay you the interest rate spread.

Before you get overly excited, let me tell you that 2.25% divided by 360 is 0.00625%, i.e. if you invested $10,000 in your position, then you would earn approx. $0.63 per day in interest.

But you need to understand that usually Forex traders are big companies, institutions, hedge funds and banks that easily hold $100 Million or more overnight and therefore earn $6,250 in interest every day. That's $187,000 per month, and they hedge their positions to minimize the risk of fluctuations in the currencies.

So one of the factors that moves currency prices are interest rates. For this reason you usually see a currency pair moving when the underlying interest rate markets are open. As soon as the interest markets close, the prices of the currency pair are moving sideways.

The second factor that influences currency prices are foreign investments. If you are a US company who wants to invest $10 Billion in Mexico, then most probably you would have to buy the Mexican Peso to pay local contractors and workers. Though some might accept payments in USD it is still very common to pay local companies and workers in their local currency. Especially if your company is manufacturing the products in Mexico but sells them in the US you will have to SELL US Dollar and BUY Mexican Pesos on a large scale, since your income is in US Dollars and you have to exchange it into Mexican Peso to pay the workers in your Mexican company.

Therefore you will see currency prices moving if a government introduces new rules and regulations for foreign investors. A change in the political landscape of a foreign country can cause sharp moves in their currency, since it might affect the decision of large companies to invest in that country.

These factors are usually affecting currency prices over days and weeks, maybe even months, not necessarily within a day. However, even throughout a day you will see a sharp reaction of currency prices to geopolitical news and news that affect the interest rates of a currency.

Did you know these things about Forex trading? - Leave a comment!