Speculation is the trading of financial assets or instruments to profit from the fluctuations in price. Speculation is used in almost all assets classes, be it stocks, commodities and other financial instruments.
When it comes to currency markets, speculation is used to buy and sell currencies to profit from the movement in exchange rates. Currencies are sold in pairs and it is the ratio that changes according to the relationship of the two currencies in the pair. When one of the pair goes up, the other goes down.
Price movements are affected by political, social and economic events such as inflation, interest rates and a change in GDP or import/export numbers. These local events are difficult to know beforehand, and once they become known and reported, it is often too late to jump on the bandwagon.
The price has already been set. Nevertheless, these changes can set off a trend which an astute Forex analyst can identify and recognize and herein lie the keys for being a successful Forex trader: Knowing how to spot a trend and when to jump in, how long to hold on and when to get out.
Forex speculation is a high-risk endeavour, so currency traders spend quite a lot of time searching for up-to-date information on essential economic variables such as unemployment, inflation, and productivity growth. They are also interested in the economic institutions of a particular economy, such as labour-management relationships and financial market stability.
If these indicators lean toward higher profits, speculators believe that the currency will increase in value down the line. But if the indicators predict lower gains, such as, in some cases, from falling unemployment, speculators will unload the currency, and its value will decrease.
Foreign currency speculators operating in the forward markets can drive the forex markets in the direction they choose simply by betting on the direction in which a currency may move. For example, if enough speculative traders believe that the Yen will depreciate against the dollar, they can enter into forwarding contracts on the strength of that belief.
If no unanticipated movements in either interest or inflation take place, the market will react to these forward contracts as if the Yen has already weakened against the dollar. The speculators’ collective activities have provided the stimulus for a self-fulfilling prophecy.
Forex speculators must do their research, observation and analysis to understand the movements of their chosen currency pair. Equally important is that they have the discipline to continue to chart the fluctuations of the currency pair to the closest pip.
Starting small is vital as is keeping greed at bay. A trader should know to pull out of his position as soon as he’s made even a small profit. Waiting around for additional price movement could very well lead to losing whatever was made until then and even more.