Foreign Exchange is the process of capitalizing on the difference in currency exchange rates between two or more foreign exchange markets in order to make a profit. In Foreign Exchange, the Exchange Rates = Relative Price of Currencies.
The Key Concepts Of Forex
Since Foreign Exchange is the supply and demand for currencies you must know how it affects the Foreign Exchange Market. Some of the key concepts are yield and return, leveraging rates, and interest rates. Yield and return is simply the exchange of currency for another at a designated rate such as $1.35 equals one euro. Leveraging returns are essential how much assets you can control with your invested capital. For instance if the leverage rate was 100:1, you could control $10,000 worth of assets with as little as $100 dollars of capital. Due to to its instability leveraging rates are a double edged sword because they can yield huge profit margins as well as huge profit losses. Lastly interest rates play a critical role in the Foreign Exchange Market. In the event a country is doing well with strong growth rates and an increase in inflation, interest rates will increase to pacify inflation and control current and future growth. However, in the event a country is expressing economic strife ranging anywhere from a broad slowdown to a full economic recession, interest rates will be reduced to help the economy rebound.
Economic Circumstances that Brought Forex Into Conception
The creation of the gold standard monetary system in 1875 marked the conception of Forex. Before the gold standard came into play, countries would use gold and silver and international means of payment. The issue with this is that such metals as gold and silver could devalue or depreciate with the location a new mine or repository. The general idea now a countries currency would be backed by gold based on the fact the government guaranteed the conversion of currency into a designated gold amount. This not only gave the currency long term stability, but also flexibility as it was exchanged from one country to another. As time progressed the difference in the price for an ounce of gold between two countries became the exchange rates for the two given currencies. This officially marked the birth of Forex we know and appreciate today.
How the theory applies to United States current economic condition
Foreign Exchange is nothing more than than exchanging of currencies between two countries. In regards the the United States current economic condition, Forex directly correlates to the United States economic conditions because the United States dollar is the most prominent and well recognized currency in the world. The USD holds the title for being the dominant reserve currency. Many times traders look to the USD to buy assets from or in the United States. When aversion risk tend to run high traders turn to the stability of the USD by buying them from the United States Treasuries, which in turn creates more of a demand for USD.
Common Ground between Forex and International Trade
Whether you believe it or not international trade and Forex are directly related. International trade is the buying, selling, and exchanging of goods; while Forex is the process of capitalizing on the difference in currency exchange rates between two or more foreign exchange markets in order to make a profit. Both have to do with exchanging, but that can' t be their only correlation. The trade levels that are conducted between two nations serves as an intermediate for the relative demand of good from both nations. However, this exchange of good has to have some monetary payment. A nation with good and services that are of high interest will see its currency appreciate or gain value. When a foreign country has to convert their currency to the different currency in order to make the purchase; causing demand for that currency.
The video above gives and in depth explanation as to what Forex is and how it affects the economy.