By Jon Jacoba
Every time somebody makes a credit card purchase in a foreign country, when a firm pays it’s outsource provider in another country or a ticket in US$ and purchases it with a EUR-based credit, one or more forex transactions occur. In a few words the Foreign Exchange market is the virtual place where currencies are bought, sold and their prices set.
In an increasingly global world, where annual goods trade for developed countries (not counting services) is in the 1,000 Billion range, naturally Forex market commands among the largest over the counter financial markets.
Do people make money in Currency Trading? This is one question that many of us have been asking ourselves recently. Here is one of the largest forex hauls in history. In 1992 the British Pound exchange rate versus other European currencies was fixed by the bank of England. In order to maintain that value, the Bank fixed their interest rate pretty high, similar to the one offered by Germany. However Germany’s high interest rates were appropriate for a robust economy in need for a cool down to prevent a spike in inflation. Englands economy on the other had was in trouble. A Hungarian immigrant identified this situation, figured out that it was unsustainable and sold short 10 billion pounds. He made 1.1 Billion US$. His name is George Soros.
These are not one off incidents and have repeated itself over time. The newspapers is full of events of currencies overvalued being brought back to its true value; in the recent European crisis forex players brought the value of the Euro down when it was overvalued (from 1.3654 on April 14 2010 to 1.1925 on June 8, 2010, – 12.7%) and back up again when it was oversold (from 1.1925 on June 8, 2010 to 1.3276 on August 6, 2010, + 11.3%). Central bank interference to reach a desired value have not stopped either, as the late interventions of the central bank of Japan and the central bank of China illustrate.
Calculating currency movements is not a matter of chance alone. Disciplines and strategies such as technical analysis help to understand short terms fluctuations of a currency, where as universal indices, like the Big Mac Index, enable to spot currencies that are away from their intrinsic value and that will converge to that price within a reasonable period of time.
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