Currency speculation is merely the act of buying or selling a currency with a view to profiting from a desired fluctuation in that currency. This act is clearly distinct from buying or selling a currency for practical purposes as is typical for people holidaying abroad who need to sell their domestic currency to buy the foreign currency of the country they are visiting or indeed for a business who might, for example, be exporting goods to a foreign country and so receive payment in a foreign currency and must therefore sell the foreign currency to buy back domestic currency.
The act of currency speculation on an institutional level is linked mainly to the facilitation of international trade. Businesses wishing to exchange international currencies for payments for goods and services, or indeed for setting up business facilities in another country (known as Foreign Direct Investment) must find currency speculators willing to exchange currencies to allow them to do this.
Let’s think about an example.
Let’s say Honda are looking to open a manufacturing facility in the UK, they need to sell Japanese Yen to buy Pound Sterling and so must find a willing counter-party to do this. The counter-party will engage in this exchange if they believe that the value of Yen is likely to rise and thus yield a profit from the exchange.
Activity of this sort, linked directly to international trade and investment occurs in the “primary exchange market”.
Let’s look at another situation linked to the example above to further consider the role of currency speculation.
Honda, having established production in the UK now receive payment for all vehicles sold in the UK in Pound Sterling. When they wish to repatriate this money to Japan they need to sell their Pound Sterling holdings to buy back Japanese Yen. If they feel that the exchange rate is likely to deteriorate over a future period and thus mean less profits when converted back to Japanese Yen they may engage in speculative action to “hedge” possible losses by selling GBP in the secondary market to other speculators such as hedge funds. Positions of this nature may run on for months at a time and be altered at various times due to the anticipated outlook of the currencies in question. This sort of speculative action is needed to facilitate international trade and provide liquidity to businesses wishing to engage on a global scale.
The individual speculator.
The individual speculator, or retail trader, is engaged purely in the secondary market, simply looking to profit from the fluctuation in exchange rates. Action of this sort is on a much smaller scale, capital wise, and usually a much shorter time-horizon, with some speculators jumping in and out of the market all day in a method known as “scalping”, with other traders adopting “swing strategies” that may last for a few hours to a few days and of course some do indeed still play longer term holding positions over a number of weeks, though longer than that is usually quite rare at this level.
Individual speculators typically have a defined trading strategy built around either Fundamental Analysis or Technical Analysis or a combination of the two.
This is a method whereby the trader is looking to anticipate likely currency direction based on an assessment of two economies and therefore looking to trade currency pairs where one economy is regarded as much stronger than the other.
This strategy relies on keen observation and interpretation of economic releases as well as reference to monetary policy and key interest rates with one typical strategy being to sell currencies on the back of an interest rate cut in that country, against countries with stronger rates or a monetary policy that hints at soon-to-be higher rates. An example of this is when the European Central Bank cut the EuroZone rate on Jan 21st of this year and EURUSD sold off heavily as traders anticipating a rate-rise n America over the summer looked to profit from the interest rate policy differential.
We cover fundamental analysis in full in our Forex Trading Course and look at the various economic indicators and what they mean as well as discussing monetary policy, fiscal policy and the affects this can have on currency values.
We also post a lot of fundamental analysis in our daily reports and weekly analysis pieces to help you get a better insight into what is going on at this level.
This method relies on study and interpretation of the price charts to compose a strategy which looks to exploit certain recurring situations observed. This form of analysis covers a broad range of topics from price action, trend lines, support & resistance, chart patterns and technical indicators. These topics can be used in isolation or combined to develop trading strategies.
We cover each of these areas of Technical Analysis in our Forex Trading Course full detailing just how to use them in your own trading. We also have a selection of our own indicators that are used for trading the currency markets based on our Order Flow trading methods which look at the underlying orders in the market to determine price direction, which can be seen as technical indicators giving fundamental insights.
We also have a huge selection of educational material available for free on the website, with videos and articles covering a wide range of these topics. We’ve listed a few below:
- A better way to use ATR
- Catch a break with bollinger bands
- RSI & Order Flow Trader
- How to trade indicator divergence