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Financial Instruments in the Forex Market That an Investor Should Know

A forex market is a place where the major eight currencies across the world through the distinct financial instrument in the forex market is traded. Financial instruments have a different kind of rates. Forex is the liquid market known so far. It operates all day except on weekends. An investor should be aware this kind of financial instruments before investing in foreign exchange market.

The first financial instrument is the spot. This is a transaction that involves a two-day process. It is the quickest transaction in the forex market. It mainly involves a direct exchange between two currencies of any kind. It basically lasts within a short period. It typically involves dealing with cash because life span is very short. The transaction depends on spot rate. Spot rates are rates that exist in the market when the transaction took place.

Forward is another common mechanism that is used in foreign exchange market. The exchange takes place between two parties. They should agree upon the exchange rates and later takes place on an agreed future date. The rates that exist in the market does not play any role in determining the price or rate of exchange. The future date can be one day, one month or even after one year. The two parties should agree on the exact date and stick to the plan.

Future is also another financial instrument that exists in foreign exchange market. Future is contracts that are traded depending on the standard exchange. The future is a standard contact that is based in maturity dates.  The average maturity date of many common futures is usually three months. There is interest which is involved within these three months. These interests are paid as legal fees to the contracts.

Swap is also a financial instrument in the forex market. This where the seller and the buyer agree to exchange the currency for a particular period. The transaction can be reversed when the maturity date is met. These type of contract is not standardised. The seller and buyer can trade without any involvement in exchanges.

Options are also a common instrument used by traders in the market. The owner of the contract has right but not the obligation to explain the currencies. Both the parties should agree on the exchange rate on a particular future date. It is similar to a forward contract. The difference with forwarding contract is that in forward both the seller and buyer have an obligation, but in options, it gives only the owner the rights that one may exercise or may not exercise.

An investor should decide on the type of financial instrument that is right for oneself. Every contract involves risks. To choose the right one investors should approach forex experts to explain to them fully. An investor can practice two or more financial instruments in the market depending on the situation of the market. Some factors affect these financial instruments. It involves government policies, political factors, financial stability, hedging activities, foreign investors and balance of payments. An investor should learn how to control these elements.

Factors That Affect Foreign Exchange Rates to Investors

Foreign exchange rates play an important role in the level of country`s trade. It is very critical in the free market and also the world economy. Foreign exchange rates are the most analysed and watched by governments to find ways to manipulate economic measures. Apart from government, they also affect investor`s portfolio. There the major forces that influence foreign exchange rates especially in investing.

The first force is the difference in inflation. A country or state that consistently have a lower rate of inflation is advantageous because the value of the currency is usually high. The purchasing power of money and stock are relatively high with the currencies that are usually stable in the market. Countries that usually have a low rate of inflation are Germany, US, Canada, Switzerland and Japan. Countries that have a high inflation rate are disadvantaged because the level of interest rates are very high.

The second thing is the difference in the level of interest rates. Foreign exchange rates and inflation are highly correlated. Central banks have a great impact on both exchange rates and inflation. Changing the interest rates in the market will, in turn, affect the exchange rate of currencies. The countries with high-interest rates attract many foreign capital and investors. The opposite is also applied to countries with lower interest rates.

Another thing that affects foreign exchange rate is current account deficit. The current account is simply a balance of trade between an investor and its trading partners. It is reflected in all payments such as interest, goods, dividends and services. A deficit shows that a particular investor is spending more on forex trading market than what is actually earning. An investor requires receiving more sales and supply of currency that other trading partners.

Personal debt also affects investor. If a person engages in borrowing capital a lot the balance of trade will go down. Large debt does not attract trading partners. Large debt encourages personal inflation, and the price of the market will be low. This also affects the country` economy because the countries with large debt because of borrowing is less attractive to foreign investors.

Terms of trade also affects foreign exchange rates. Terms of trade are the relationship between the balance of payments and current account. The demand for a certain currency should be high to attract more people. The value of the price will be high if there are favourable terms of trade. The interest rate will, in turn, rises. The investor will end up earning more in the market because terms of trade are favourable.

Another thing that usually affects investors a lot in the forex market is the economic performance and political stability. Foreign investors prefer countries that have a strong economic performance so that they can invest in their capital. The Foreign investor will draw funds from countries that the political and economic performance is at risk. The political stability of a particular country creates confidence to investors because the movement of capital is very stable. The risks rate is extremely low.

How Oil Prices Influence Currency Fluctation

In the Forex market, the values of currencies move up and down as a result of many factors, including — but not limited to — supply and demand, interest rates, economic growth and political conditions. Because of this, the more dependent a country is on a large domestic industry like oil, the stronger the correlation will be between a national currency and its industry’s commodity prices.

In general, there is no uniform rule for determining what commodities a given currency will be correlated with and how strong that correlation will be. However, some currencies provide good examples of commodity-Forex relationships — and oil, in particular is one of the most powerful commodities when it comes to influencing the value of currencies associate with its production.

Here are 3 tips about oil prices and their effect on Forex trading that all traders need to know:

Oil Prices Affect Currency Values

For an example of a currency that is directly connected to the price of oil, consider the Canadian dollar. When the price of oil goes up — usually because of worldwide demand and the limitations put on oil production by OPEC nations —  the Canadian dollar tends to become worth more when based against other currencies. Canada is a net oil exporter, so when oil prices are high, Canada often receives greater profits from its exports, which gives the CAD a boost on the Forex market.  Therefore, when trading pairs involving CAD (such as USD/CAD or CAD/USD, it is wise to have an understanding of the current forces working on oil prices.

Recent times have seen oil prices come down to the lowest they have been in years —  under $50 a barrel, which has had a huge impact on countries maintaining large oil resources, including Norway and, of course, Canada.  A recent headline on OilPrice.com says it clearly, “Conflicting News Keeps Oil Prices Down,” and wise Forex investors always keep an eye on major nation commodities before committing to their trades.  

One other quick example to explain the connection between commodities and currency value:  The Australian dollar (AUD) is positively correlated with gold. Because Australia is one of the world’s biggest gold producers, its dollar tends to move in unison with price changes in gold bullion. This means that when world gold prices rise significantly, the Australian dollar will also be expected to appreciate against other major currencies.

Oil Prices Affect Other Aspects of the Economy 

Along with the direct result changes in oil prices have on a country’s currency value, it is important to take into consideration the other subsequent effects that happen when oil prices rise or fall.  Before the lowering of oil prices, cities in Canada such as Calgary had huge construction and housing booms, as workers poured into the city to take oil-related jobs and make money from the growing business. However, the change in oil prices from 2014 to 2015 had devastating consequences for Calgary’s housing market, as seen in this article from the time.

Similar events are currently happening in Norway, and while USD/NOK is perhaps not the most traded pair, investors who are interested in trading the Krone would be advised to stay on top of articles like this, which show that recently housing prices in Norway have fallen more than expected, thanks to the price of oil driving down the economy.

Understand Why the Price of Oil Moves 

If you are trading currencies that are affected by oil prices, it would be a good move to have an understanding about the forces that drive the price both up and down. Crude oil prices move largely because of the perceptions of supply and demand affected by worldwide output, as well as the overall global economic prosperity. In the commodities market, an oversupply of oil and shrinking demand encourages commodities traders to sell crude oil markets to lower prices. Rising demand (and declining production) encourage traders to bid crude oil to higher prices.

Within the past decade, we have seen everything from the surge of crude oil to $145.81 per barrel in April 2008 to downtrends in August 2015 bringing the price down to $37.75 per barrel.

Where oil goes, currency values will follow, and smart Forex traders will always monitor oil prices to help them determine the trends that could follow immediately from how the world prices its oil.

3 Critical Factors that Determine Oil Prices

 

3 Critical Factors that Determine Oil Prices

Forex traders have learned that oil prices have a profound effect on the values of currencies, with rising oil prices helping certain countries (such as Canada and its CAD) and falling oil prices leading to these currencies losing value.  Smart Forex traders understand that keeping an eye on oil prices can be helpful to spot trends in the market as early as possible, and to that end, they watch oil prices for changes that could have an effect on the currencies they trade.

To better understand how these oil prices are determined in the first place, this article will take a look at the three main factors considered by commodities traders when they develop the bids that create oil prices:

3 Factors Commodities Traders Use To Set Oil Prices

#1 – Current supply in terms of output. For many years the current supply of world oil was controlled by the Organization of the Petroleum Exporting Countries (aka “OPEC”) and its production quotas. However, when U.S. shale oil production doubled between 2011 and 2014, an oil glut was created, and the price of oil fell as low as $45/barrel in 2014.

Prices fell again in December 2015 to a low of $36.87 a barrel, and typically OPEC would have cut supply to keep oil at OPEC’s target of $70 a barrel, but it instead allowed prices to fall, knowing that money would still be made as long as oil remained above $20 a barrel.

Unfortunately for the new shale oil producers, they required a price of at least $40-$50 a barrel to stay financially solvent, and OPEC saw this as a way to remove their new shale oil competitors.

OPEC bet correctly that the shale oil producers would go out of business, allowing OPEC to keep its dominant market share, which began to happen in 2016.

#2 –  Access to Future Oil Supply. Along with the current oil supply, investors in oil keep an eye on oil reserves, which include what’s available in U.S. refineries as well as in the Strategic Petroleum Reserves, an emergency fuel storage of petroleum maintained underground in Louisiana and Texas by the United States Department of Energy. (This is the largest emergency supply in the world, with the capacity to hold up to 727 million barrels.)

These reserves can be accessed very easily, increasing oil supply if prices get too high. Saudi Arabia can also tap into its large reserve capacity.  For investors, the existence of these oil reserves serves as a balance to low demand and subsequent rising prices.

#3 –  Demand for Oil. Ultimately, and unsurprisingly, the world’s demand for oil — particularly from the United States — is a huge factor that influences prices. Each month, the Energy Information Agency provides estimates for the demand for oil. In general, demand usually rises during the summer vacation driving season beginning with Memorial Day, and to predict this summer-time demand, forecasts for travel from AAA (the American Automobile Association) are used to determine potential gasoline use. During the winter, the Energy Information Agency uses weather forecasts to determine the potential use of home heating oil.

One other factor that is impossible to predict, but absolutely has an impact on oil prices, are unforeseen crises in oil-producing countries. These potential world crises often dramatically increase prices, especially when traders worry that a crisis will limit the supply of oil.

One example of a crisis like this happened in January 2012 after inspectors found proof that Iran was closer to building nuclear weapons capabilities, after which the United States and the European Union began financial sanctions.

Iran threatened to close the Straits of Hormuz, and the U.S. responded with a promise to reopen the Strait with military force if necessary. The possibility of an Israeli strike was also a concern.

As a result, oil prices bounced around $95-$100 a barrel from November through January, anc then by February, oil broke above $100 a barrel and stayed there. You probably remember that gas prices in the U.S. also went to $3.50 a gallon, with forecasts saying that gas would be at least $4.00 a gallon through the summer driving season.

Along with these factors, oil traders also watch out for natural disasters and other events that could prevent the production of oil. As a Forex trader, you should take the time to learn more about oil prices and how they are set so you may be able to profit from trends that result from this important commodity.