Trading the World’s Currencies Requires a Fundamental Perspective

Global investors are a fickle lot.  If one investment medium is not delivering the desired returns, then many broadminded investors often look for opportunities elsewhere.  In the past decade, one arena that has attracted a healthy number of new recruits is currency trading.  New and improved trading software and a flexible schedule that allows for trading nearly any time of day are the primary draws.  Forex trading, however, involves high risk, and many hours of preparation and specialized training are prerequisites if you wish to be successful in this genre.

Experts will tell you that there are three factors for success – knowledge, experience, and emotional control.  The latter is often the most difficult to acquire, since it has more to do with your personal psychological programming than anything else.  Experience can come from practice trading on a free “demo” forex account that uses “virtual” cash and real time quotes to aid your learning the vagaries of the forex market and developing strategies that work.  As for knowledge, seminars and tutorials are mandatory, and you should seek out a “mentor” to guide your early development.

One key area of your educational process will be devoted to what are known as the “fundamentals”.  Fundamental data, whether economic, political, financial, or crisis related, are what move the market.  Developing your trading strategy starts here.  Let’s begin by taking a look at the Indian Rupee versus the U.S. Dollar for the past year in the chart below:

 Forex Chart

The “Blue” line represents the pricing behavior for the Rupee, reflecting a 20% decline in value over the period.  What fundamental factors led to this decline?  By understanding the past, you can learn to appreciate what needs to be known when you wish to forecast what might happen in future.  Here are a few of the causes for the drop in value:

  • Interdependencies: In today’s modern era of globalization, our economies are interconnected in so many ways that it is sometimes difficult to discern the individual forces at play.  Traders deal with this phenomenon by searching for “correlations” to guide their fundamental interpretation.  The pricing behaviors for the five items presented are very similar, with slight adjustments due to local considerations.  India’s economy is very dependent on the global economy in general, and Copper is one proxy for the health of the global economy.  As Copper fell, it dragged the Rupee down with it over time.
  • Economic Data: Any government releases related to GDP growth, government spending, investment flows, trade balances, and foreign exchange reserves are just a few of the factors in this area that can move forex rates in the market.  GDP growth in India has slowed to 5.3% over the past year, imports have been greater than exports, and investment flows have been outward, all reasons for the general decline above.  Inflation has also risen to 7.6%, thereby reducing the purchasing power of the Rupee and its value versus other currencies;
  • Financial Data: Interest rate changes and monetary policy from the central bank are key components here.  The RBI recently reduced rates in April by half a point.  This reduction accounts for the modest drop in April when other currencies and stocks remained flat over the month;
  • The European Debt Crisis: India has historical trading ties with Europe.  Any drop in their demand for imports will ripple through all economies of the world, but more so with respect to India.

These items are just the tip of the forex “iceberg”.  Be sure to invest the time up front, if you wish to reap forex dividends down the road.

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