On a previous controversial article I wrote for Barbara Friedberg Personal Finance, I mentioned an inflation strategy trading foreign exchange. There were 27 comments on that post alone by those who were for and those who were against trading currency. Most people would agree that foreign exchange is risky but I would say that any trading is risky if you don’t know what you’re doing.
Economic analysis is an excellent tool to make trading forex less risky. Economic analysis can be compared to stock analysis very simply.
In economic analysis you look at a country’s balance of trade. In stock analysis you look at a company’s financial statements.
A stock investor would pay attention to a company’s earnings announcements. An economic analyst would pay attention to a country’s GDP.
A stock investor would look at a company’s price to earnings ratio, whereas an economic analyst would consider the strength of a country’s currency.
As you can see, economic analysis is not so different from analyzing a stock. Both take fundamental factors into account.
When I start my economic analysis I use an economic calendar. It tells me when the U.S. plans to release the CPI numbers, GDP and various confidence surveys. Those announcements give me an idea of how to trade certain currency pairs.
For example, if the U.S. releases the new housing starts number and it is better than the one that was previously released, that is a good sign for the U.S. dollar. I would be bullish on the dollar. And if that sort of good news kept coming out, I would continue to stay long the dollar.
However, if the British central bank decides to raise rates and also has good news continue to come out, I would be more bullish on the Pound versus the Dollar and I would prefer to exchange dollars for pounds.
Economic analysis is not difficult when you take the time study the effects. Pay attention to what the stock market does the next time the CPI number is released. The foreign exchange markets will react similarly and you will be a better trader.
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Barb Friedberg says:
May 17, 2011 at 8:04 pm (UTC -4 )
LaTisha, As wild and crazy as our government is with spending, some of that money goes to very useful resources. Economic data is a strength of the government’s information.
LaTisha D Styles says:
May 18, 2011 at 7:52 pm (UTC -4 )
That is so true. I remember when I first learned about the Balance of Trade and it really opened my eyes to a lot. For example, the U.S. will always have a trade deficit because we import more than we export, and unless we follow a policy to strengthen the dollar we will continue to have a trade deficit.
Travis@TradeTechSports says:
May 18, 2011 at 11:01 pm (UTC -4 )
I agree that fundamental analysis is similar, however, people always need to remember that you can go negative big time with futures and forex. Always have stops in place or an “uncle” point, because overnight news could come out and there goes all your money if you are on the wrong side of the trade.
LaTisha D Styles says:
May 19, 2011 at 6:50 am (UTC -4 )
Yeah, I learned this the hard way the first time I started trading. I went to sleep with a yen trade on and woke up to a huge “still open” loss! ouch.
Barbara Friedberg says:
October 18, 2011 at 11:24 am (UTC -4 )
Tisha, For me, I like to stick with the simpler strategies; dollar cost averaging into a diversified portfolio of index funds. Yet, good luck with the forex trading, I’m interested to see how it works out in the long run!
James Vincent says:
November 20, 2011 at 11:26 pm (UTC -4 )
I understand that you can use economic analysis to predict how a currency pair will behave. But even if you get it right you are going to make peanuts if you just buy a currency and wait for it to rise in value.
What makes forex profitable (and exciting) is leverage. Leverage also means you can get wiped out in seconds. Unfortunately most people don’t really appreciate this and get burned as a result.
LaTisha Styles says:
November 21, 2011 at 8:12 am (UTC -4 )
Yes, but leverage is a double edged sword and it can work for and against you. I try to keep my overall leverage low and risk no more than 5% of my account in any one trade.
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