Forex for Speculation
Factors such as interest rates, trade flows, tourism, economic strength, and geopolitical risks affect the supply and demand for currencies, resulting in daily fluctuations in the forex markets. There is an opportunity to profit from changes that may increase or decrease the value of one currency compared to another. Expecting one currency to weaken is basically the same as assuming the other currency in the pair will strengthen because the currencies are traded as pairs.
Imagine a trader who expects US interest rates to rise compared to Australia while the AUD/USD exchange rate is 0.71 (i.e. requires 0.71 USD to buy 1.00 AUD). The trader believes that higher US interest rates will increase the demand for US dollars, and therefore the AUD/USD exchange rate will fall because it will require fewer and stronger US dollars to buy Australian dollars.
Assume the trader is correct and interest rates go up, reducing the AUD/USD exchange rate to 0.50. This means that it takes 0.50 USD to buy 1.00 Australian dollars. If the investor sells the Australian dollar and continues to buy, he will have benefited from the change in value.
Forex Trading: A Beginner’s Guide.
Currency trading can be risky and complex. The interbank market has varying degrees of regulation, and forex instruments are not standardized. In some parts of the world, forex trading is almost completely unregulated.
The interbank market consists of banks that trade with each other around the world. Banks themselves have to identify and accept sovereign and credit risks, and have established internal processes to keep them as safe as possible. Such industry regulations are imposed to protect each participating bank.
Since the market is done by each of the participating banks that bid and bid for a particular currency, the market pricing mechanism is based on supply and demand. Since there are such large trade flows within the system, it is difficult for fraudulent traders to influence the price of the currency. This system helps create transparency in the market for investors who can access interbank dealings.
Most of the small retail traders trade with relatively young and partially unregulated forex brokers/dealers, who can (and sometimes do) re-quote prices and even trade against their clients. Depending on where the dealer is located, there may be some government and industry regulations, but these guarantees are not consistent around the world.
Most retail investors should spend time investigating a forex trader to see if they are regulated in the US or UK (US and UK traders have more oversight) or in a country with lax rules and supervision. It is also good to know what type of account protection is available in the event of a market crisis, or if the trader goes bankrupt.