The current state of the global economy has produced several unique situations. In developed nations, for instance, inflation has become commonplace. In the US and some of the world’s other financial bellwether countries, governments are setting high interest rates as a way to bring rates down. The strategy doesn’t always work, and even when it does, results can be slow to appear. But for foreign currency traders, these kinds of otherwise negative conditions spell opportunity.
How can forex enthusiasts use high interest rates, soaring inflation, and similar macroeconomic factors to their advantage? The main way they do so is by studying the relative strength of national currencies. For those who can figure out which of the two national currencies is trending upward and which one is set to weaken, the potential trading profits are potentially unlimited. But what are the general risks, opportunities, pros, and cons of foreign currency trading, or forex, in a global economic environment where inflation and rising interest rates are commonplace? Consider the following.
Opportunity: Monitor Inflation & Interest Rates
With inflation at record levels in so many nations, forex enthusiasts can more easily spot important differences between national currencies. Because inflationary pressures tend to weaken a domestic currency, a rising rate in one country but not in another can serve as a clear signal that the pair is out of balance. All else being equal, the nation with a higher inflation rate will experience more monetary weakness than one with a lower rate.
Risk: Ignoring Relative Strength
Anyone who wants to open an account and start trading FX should take time to learn more on what is forex trading and how to choose major and minor pairs strategically. The USD/JPY, or US dollar against the Japanese yen, is one of the most popular choices for FX enthusiasts worldwide. However, it’s far too easy to focus on one nation and forget that successful forex trading is about gauging the relative strength of one nation’s currency against another’s. The good news is that practitioners can work around this common dilemma by studying the historical relationship between two given nations’ exchange rates.
Pro: FX Markets are Open to Everyone
For new traders, access to FX markets is never a problem. Part of the reason for this beneficial environment is that foreign exchange brokers allow account holders to use a significant amount of leverage and to practice in demo accounts before putting their own money at risk. Opening balances are sometimes as low as one dollar, and users can trade from any connected device. At the top online brokers, it takes just a few minutes to open and fund an account.
For those who want to test drive different brokers before opening accounts, the majority of reputable FX brokerage firms offer no-cost demo accounts in which you can check out the platform’s functionality and get a feel for the support services offered by a particular company. When it comes to leverage, FX platforms typically let traders use between 20:1 and 50:1 ratios when trading major currency pairs. Unlike traditional stock and commodity markets, where traders must apply for margin accounts, leverage is commonplace and freely offered to all account holders.
Con: High Volatility & Leverage
Price volatility and leverage can be pros or cons, depending on the situation and trader. When they work against you, it’s usually because price swings are wide, and you used more leverage than you should have. According to a common rule among FX enthusiasts, leverage can be a friend or an enemy. It means having more trading power, but it also magnifies potential profits and losses. For those reasons and many others, most new FX practitioners try to keep leverage factors low and avoid operating in excessively volatile economic environments.
Opportunity: Shorting Weak Currencies
Stock traders must follow strict rules about shorting, but there are no such restrictions with forex. That’s primarily because one can buy or sell any currency with equal ease. In fact, every time someone purchases a currency pair, they’re going short and long at the same time by purchasing the first half of the pair and selling the second half. If you buy USD/JPY, you’re going long on the US dollar and shorting the Japanese yen. If the dollar gains strength relative to the yen, then you would stand to earn a profit on the position. If, on the other hand, the yen strengthened and the dollar weakened, you’d suffer a loss relative to the size of your purchase and how much the dollar deteriorated against the Japanese yen.
