Trading Forex and the Theory of Relativity!

Albert Einstein would have loved the foreign exchange market. It is the only market in which it operates with relativity!

When you “buy” a currency in the forex market, you are not actually “buying” anything. What you are doing is opening a contract on one currency value relative to another.

Currency contracts are quoted at the value of one currency (the “quote”) relative to another (the “basis”).
For example, the most traded currency pair is the Euro relative to the US Dollar. The pair trades as EUR/USD. In this case, the euro is the quote currency. The US dollar is the base. So you could look at the EUR/USD trading at 1.5929 as the euro trading at US$1.5929 or it takes US$1.5929 to buy one euro.

Most traders look at the country’s economic fundamentals that underpin each currency. They then look at the relative strength or weakness of one economy versus another. When they see one country’s economy getting stronger while another’s weakening, they see trade going in favor of the stronger country’s currency.

Here is an example. The Australian economy has been very strong recently because its economy is very tied to the price of raw materials: it is the largest exporter of gold. The demand for gold has been, and continues to be, on the rise from the Chinese industry. India is also demanding more of the precious metal, as its growing middle class is better able to afford the gold jewelry that Indian women have always wanted. This has been a boon to the Australian dollar for many reasons, but one is that the Royal Bank of Australia, the Australian equivalent of our Federal Reserve, has had to raise interest rates to prevent the Australian economy from overheating and triggering the inflation.

At the same time that Australia has been raising its overnight rate, our Federal Reserve has been lowering ours. Therefore, I would expect to see a relatively stronger Australian dollar against the US dollar.

So, this is trading. If you open a contract in AUD/USD, you would do so in favor of AUD. The other advantage of taking this position, and another reason to expect a growing force in your favor, is that you are paid interest each day you hold the position. Yes, the interest differential between the two currencies is deposited into your account every day the market opens!

A look at the AUD/USD 5-year chart shows the trend.

This is the theory of relativity in action!