Forex Trading

After spending a lot of time buying and trading on both domestic and foreign markets, you will find that the process becomes easier and almost intuitive.  You no longer have to work so hard to determine currency conversion or find the next big explosive commodity.  It will be like second nature for you.

What, then, becomes the next big challenge for someone trading on the open market?  What keeps things from becoming monotonous and boring?  First of all, there is always something new and different happening on the Foreign Exchange Market.  Remember, it operates 24 hours a day, and you never know what you will find when you wake up in the morning.  However, there are various ways that you can take advantage of the variance in currency conversion and a lag in time between markets that can affect trading values.

Arbitrage

There are some commodities that are traded in multiple currencies on multiple markets on Forex.  Although computers have made worldwide communication almost lightning fast these days, all of these markets can trade together with fairly equivalent values for the securities shared across currencies. 

However, the system is not perfect, and the value may rise or fall in one country and currency prior to the same change in value reaching across another border.  Seasoned traders have learned to take advantage of this lag in the market trending by using a process called arbitrage.  In this transaction, you purchase the particular stock or security on the market with the lower price while simultaneously selling the same in a market where the value is higher.  The process is a bit complex, so we will use an example.  Let’s say that one U.S. dollar is equivalent to .5 British pounds, meaning that everything is going to be twice as expensive in British pounds. 

Now, let’s take a look at the price of a stock that is traded on both markets.  If they were equivalent, then the stock would trade for two dollars in the United States and one pound in Britain.  However, if something happens and the stock value drops in Britain, it is six hours ahead of the United States, and this drop may not hit the American market immediately.

If the value of the stock drops in Britain to .8 pounds, the purchase price is now below that of the price in dollars due to the currency conversion.  In this case, arbitrage would take place when you bought shares of the stock in on the British market in pounds and sold it on the U.S. market in dollars, benefiting by the slow communication of the fall in value of the stock.  In effect, you will make $.40 per stock.

Volatility of Currency Conversion

Another way to take advantage of the ever-shifting value of each individual currency is to trade based on the changing rates.  What exactly does this involve?  You must closely watch the changing conversion rates.  When a currency conversion rate changes drastically, it is time to make a move.  This is very similar to arbitrage, but the area is much riskier due to high volatility.  For instance, if you have purchased a stock in the scenario above on the U.S. market for two dollars a share, and suddenly the British pound gains value, dropping to a conversion of only half a pound for every two dollars, you would want to sell your shares on the British market because the value of a pound is higher and now has greater purchasing power.

One piece of advice to keep in mind, though, is that it is best to immediately dispose of all liquid assets in foreign currency, usually in the same day.  This is referred to as tomorrow next because it takes two to three business days for foreign currency to be delivered, and by exchanging the currency for value in stocks on the same business day, you avoid having to take delivery of the currency altogether.