Here’s a very important detail about Forex trading that is often left out. To understand this bit of information, we need to know a little bit about the Forex market and the function of different currency pairs.
The reason for which so many people miss out on Forex trading is because they fail to understand the basic function of each currency pair. You see, there are basically three types of currency pairs, FX pairs, mkt pairs and base currency pairs. Let us now go over these.
The first type of currency pair is the Base currency pair. This is where you buy and sell one currency at the same time and it’s basis is the same currency. Let us say that you are buying one US dollar for one Euro.
The next currency type is the Forex major currency pair, also known as the major currency pairs. This currency pair is where you buy and sell currencies. Here you can either buy a currency at a lower rate and sell it at a higher rate.
The last type of currency pair is the FX major currency pair. This is where you buy a currency and then sell it at a higher rate and the selling price is in exchange for a currency. This is where you are actually using your money for buying and selling.
There are actually two fundamental factors you need to take into consideration when you trade Forex. These are currency pair volatility and interest rates. These two factors affect the currency prices and hence determine the Forex market fluctuations.
Now, let us now talk about the role of currency volatility and interest rates. When the market moves between two positions, it is called currency volatility. The other term used for it is cross-over.
The volatility is measured by the difference in the value of the two currencies involved in the two positions. The interest rates act as a balancing effect to the currency volatility.
Now, let us now look at the roles of currency pair volatility and interest rates. If the volatility is high then there will be greater amount of change in the values of two currencies and this will translate into an increase in the value of the currency.
Therefore, interest rates will act as a smoothing mechanism to maintain the movement in the price of the currencies. But the good thing about this is that currency volatility and interest rates can also change each other in different ways. This is another reason why you need to understand the difference between these two.
Now, to conclude, here is something very important that you should understand about Forex. Currency pairs that have high volatility will tend to have an increase in value and are prone to change in their value as well.