Trading the FX markets from a fundamental point of view means, analyzing the two economies represented by the currency pair.

 

That being said; imagine the world’s economy and let’s just take the example of the United States and Eurozone. The currency pair in this case will be the EURUSD and they form a currency pair.

 

This currency pair is moving based on the economic differences between the US and Eurozone economies and these economic differences can be spotted by watching closely the economic calendar and looking for the relevant news to be released.

 

But nothing matters the most to currency trading than what the central bank is doing when it sets the interest rate for a specific currency and therefore the currency pair is moving based on the interest rate differential between the two currencies that form the pair.

 

In other words, using the EURUSD example, if the interest rate in the United States, as set by the Federal Reserve, is 2% and the one in Eurozone is lower and moving lower, it is clear that the US dollar should be favored when compared with the Euro and the EURUSD pair will trade with a bearish tone. After all, everyone wants to own a currency pair that pays the highest interest.

 

Trading a currency pair comes with some costs too. Beside the broker’s commission, one has to pay the swap on a daily basis, and in almost all pairs the swap is negative, so at the end of each day an amount is being deducted from the trading account.

 

If the swap is positive, at the end of the trading day it will be added to the trading account as well. This swap represents the interest rate differential and, again, it is changing based on what the central banks are doing.

 

In Europe now, with interest rates into the negative territory, being short the EURUSD pair pays a positive swap, so a small amount corresponding to the interest rate differential will be added to the trading account.

 

ecb

 

On the other hand, being long on the pair is quite costly as each and every day represents a cost for the trading account and if you trade a ranging pattern, like a triangle on the daily chart or even on the bigger time frame, then the costs associated with the swap should be covered with other trades.

 

Once again, another proof that everything in the FX market is related to what the central bank is doing when it is meeting to set the interest rate for the period to come. Therefore, when interpreting the economic calendar it is vital to know when the central bank of the currency pair you are trading is meeting.

 

The US dollar being the world’s reserve currency, it is mandatory to know all the time what the central bank will do with the rates. Even if you trade a currency pair that does not have the dollar in it, or a cross as it is being called, Fed meetings still matter, as in the case of emerging markets, volatility will be high.

 

Fed meets every six weeks and in between the minutes of the previous meeting are released in order for market participants to have an idea what the discussions were about. Based on those minutes and the economic releases in between, traders will have an educated guess regarding what Fed’s intentions are and where the interest rates in the United States may go next.

 

Based on that, swaps can be determined and a position can be traded based on those swaps.

 

For example, it is paying a positive swap to be long AUDUSD but negative to be long EURUSD, so, assuming things will stay the same in Australia, if the Fed is signaling a bearish US dollar move, it is advisable to trade the AUDUSD to the upside and not the EURUSD as this one will cost you a negative swap.

 

To sum up, the thing to do is to mark on the economic calendar the dates for the major central banks meetings and interest rate decisions and to make sure you follow any changes in the monetary policy and then double check at your broker how those decisions affected the swaps.

 

fomc

 

This way, you’ll always know what currency pairs are indicated to be traded in a general US dollar move in such a way your account won’t have to suffer from paying too much swap.

 

Like what you've read?

Join thousands of other traders who receive our newsletter containing; market updates, tutorials, learning articles, strategies and more.