Thinking the Forex Markets

One of the main problems new traders have when they begin their journey down the education path to self-empowerment is that they skip the most important first step, how to properly “think” money and markets. Many of my articles deal with thinking about the trading side of the equation; everything from the mechanics of when to buy and sell to understanding the psychology of you and the person on the other side of your trade. Today, let’s take a walk through the history of one of the best trending markets in the world, Forex. It is an important first step in properly thinking the Forex markets, which is key when attaining an edge in anything we do. The more prepared we are, the more we understand, the better the results.

Strong economies tend to have strong currencies. When we trade the Forex markets, we are trading economies. Therefore, supply and demand for currency depends on the current and expected future health of a country’s economy. To keep things simple let’s discuss the chart just below. The way we value the health of a company when assessing a stock’s valuation is not all that different from how we value a country’s currency.

Foreign Currency (Forex) trading traces its history centuries back since before the Babylonians. While they were the ones credited with the first use of paper notes and receipts, forms of currency had existed for quite some time already. In the beginning, the value of goods and services was expressed in terms of other goods and services, also called “the barter system.” Limitations of this system were the catalyst for establishing more generally accepted methods of exchange.

Means of Payment/Reliable Storage of Value Evolution

Stones, Teeth, Feather Metals: Gold and Silver Governmental Paper Money

then…then…

Before the First World War, most Central Banks supported their currencies with convertibility to gold. However, the gold exchange standard had its weaknesses of boom-bust patterns. As economies moved more and more to paper money not supported by gold, other problems arose. A greater supply of paper money without the backing of gold led to devastating inflation resulting in political instability.

Benton Woods

Agreement: July 1944 (end of World War II)

This agreement created a global currency system built on the US Dollar. The result was to fix the US Dollar at $35.00 per ounce of Gold and also fix other main global currencies to the US Dollar. This was initially meant to be permanent but things change. The system ran into trouble when national economies moved in different directions during the 1960’s. The system collapsed in the early 1970’s when US President Nixon suspended gold convertibility. At a time when the US was going through economic hardship, the US Dollar was no longer suited as the only international currency.

Forex Today

Over the past few decades, foreign exchange trading (Forex) has developed into one of the world’s largest global markets. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values based on pure supply and demand for currency. The Candles on your trading screen represent the footprints of buyers and sellers. Each and every candle is created because of an ongoing demand and supply relationship. This order flow is driven by demand and supply for Currency based on people’s perceived value.

OTA Supply/Demand Grid and Market Screener: GBPUSD – 5/8/15

Notice on the chart above from last week of the GBPUSD, a supply level is identified in this market. When price comes back to this level, it declines strongly from that area. What is key to understand is, any and all influences on price are reflected in price. We don’t need to focus on or consider the economic influences on price in this market because all those influences are reflected in price and seen on the chart.

At the end of the day, this all comes down to objectively quantifying demand and supply when looking at your Forex charts. The Forex markets are filled with economic news, economic reports, and many more potential influences on your decision making process. Try not to let this subjective information influence you too much. Instead, understand that the movement of price in these markets is nothing more than an ongoing demand and supply equation for currency. Low risk, high reward, and high probability trading opportunity is present when this simple and straight forward equation is out of balance. For more information on exactly what a demand and supply imbalance looks like on a price chart, please see my prior articles.

Hope this was helpful, have a great day.

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