Forex Investment and Currency Trading

Fundamental analysts collect data about what is happening in the economy and try to understand how these economic conditions impact the currency value of a particular currency, as well as predict what might happen to the currency’s future value. Many things can impact the state of the economy, including monetary policy set by government agencies, capital and trade flows, production, and employment (or unemployment). Understanding these key economic indicators and how they impact the value of money is critical for currency traders.

Watching the Flows

Money flows in waves. Watching those flows can help you determine where your next best trading opportunity might occur. There are two types of money flows you need to watch—capital flows and trade flows.

Capital Flows
Capital flows gauge the amount of a currency that is bought or sold for the purpose of capital investment. When you read that a country has a positive capital flow balance, this means that foreign inflows of capital exceed the outflows of capital. The reverse is true if there is a negative flow balance.
There are two types of capital flows you need to watch—physical flows and portfolio flows. Physical flows involve investment activity that produces products and services, while portfolio flows involve the exchange of equities, such as stocks and bonds.

The physical flows currency traders want to watch include:

• Foreign direct investment—Whenever you read that a major corporation is building a plant in another country, it is considered a foreign direct investment. For example, if Coca-Cola builds a processing plant in China, that would be a foreign direct investment.
• Joint ventures—If you read about a U.S. corporation partnering witb a corporation in another country, it is considered a joint venture. For example, if you read that Toyota and GM are working together to build a hybrid car, that would be a joint venture.
• Third-party- licensing agreements—If you hear that a foreign company is buying the rights to patented products or business processes or the rights to use a brand name, this would fit in the category of third-party licensing agreements. For example, if you hear that Chinese computer makers have signed agreements to buy operating system software from Microsoft, that would be a third-party licensing agreement.

Any major deals affecting physical flows could move the currency market, because in order to carry out these agreements, currency would need to be bought and sold. Currently, most of the world’s capital belongs to the United States, Europe, and Japan, while most of the world’s cheapest labor is found in China, India, and other emerging nations.

What we see today in the business world is many agreements that send capital to the emergine nations through various means of physical flows. By doing this, they take advantage of cheap labor markets. In fact, the World Bank found that net private capital flows to developing countries in 2005 hit a record high of S491 billion, driven primarily by privatizations of formerly government-owned industries, mergers, and acquisitions.

Growth in the developing nations is also much stronger than that of the developed nations. China and India lead the pack.

Money has been moving from developed to emerging nations for years, so why do we seem to
feel the economic pain in the United States more than we have in past years? One major factor that explains this new pain is the speed at which capital can flow. Today, massive amounts of capital can move quickly around the world through electronic transmission many times in a matter of seconds. In addition, the costs of moving this capital from one country to another dropped dramatically over the past 20 years, as barriers to currency trading were lifted.

Unfortunately for U.S. workers, what all this means is that corporations that own all this capital have a wide variety of high-return investments for their money. As corporations find better investments outside the country, U.S. workers get downsized, yet U.S. corporation profits continue to rise dramatically.

Currency traders can make up for some of these lost wages by taking advantage of the money to be made as capital moves around the world. For example, when a U.S. corporation invests in a business in China, that company must sell dollars and buy Chinese yuan. The fact that many U.S. corporations are currently investing in China does not have a big impact on the value of the dollar because the Chinese yuan is pegged to the dollar, but that could change in the future if the yuan is allowed to flow freely. Generally when large amounts of a currency are sold, the currency will drop in value.

In addition to physical flows, you should also watch portfolio flows. These involve the buying and selling of stocks (equity market) and bonds (fixed-income market).