Any economics student would agree that most of the graphs and ratios in his class didn’t seem very practical, meaning he couldn’t take the things he was learning and immediately apply them to real life. This background in economics, however, is essential to understanding the central relationships in the global economy if you want to make real investments in the stock markets or the foreign exchange market.

When it comes to trading the forex market, understanding certain fundamental factors, such as interest rates and how they relate to the economy of a specific country, should become second nature, and it’s the boring theory you learned in class. of economics which can help solidify this. essential understanding. To get out into the real world and find profitable investments, you must first learn all the theories that are supposed to govern the behavior of money and financial markets. Only when you understand how most people think the economy should behave can you identify which instances go against typical economic theory, which could then present a viable buying or selling opportunity.

Much of the forex activity that occurs today between the major currencies is centered around the US dollar, and the currency pairs that most brokers call “major” are currencies like the pound or euro that are traded against to the dollar. As such, when there is a fundamental change in the US economy, such as a change in short-term interest rates, there is an opportunity to take profit by buying or selling the dollar against these other currencies.

As traditional economic theory says, when the Federal Reserve lowers short-term interest rates, it should stimulate business growth in the economy, since the cost of doing business is lower. This is why the Federal Reserve will typically lower interest rates when it’s time to grow the economy, and raise interest rates when it’s time to slow economic growth.

An important thing to understand is that an interest rate is literally the cost of money. When the interest rate is low, money is cheaper and borrowing should increase (in theory), and with high interest rates, people are more motivated to save their money and not borrow more. But when a currency has a high interest rate, this will also increase foreign investment and the levels of foreign capital coming into the country, because if people in Europe or Britain can earn more interest by buying dollars, this is where a profitable forex opportunity. arises

But so far, this is just theory. In theory, the forex market will follow this exact relationship with changing interest rates, but the market is made up of people, and most people are insecure and unpredictable. It is when the markets go against established theory that the real opportunities for big profits arise. A good historical example of Fed mismatch theories with reality is around the years 2001-2002.

At about this time, the stock market fell as there was a massive loss of interest in internet companies and the US government was trying to fund a new war effort. In 2001 the Fed lowered interest rates more than 4% and in 2002 interest rates fell another 1%, as this action should have stimulated economic growth and increased business.

This time, however, economic growth did not increase as expected. Lower interest rates were expected to stimulate the economy, but the results were fear in the markets and a decline in business in the United States. While in theory it might have been a good time to buy dollars as it could go up in value, the real money was made by people who saw fear in the markets and sold the dollar as it fell in value. This illustrates why it’s important to know fundamental basic economic theory, because in the complicated world of forex trading, theory doesn’t always match reality.