Foreign exchange limits

Hello everyone

Today i am going to talk about a very important topic. i believe this is very important to forex trading in general. if i use one word to describe forex and that is "Economics", then i can also use one word to describe economics. and that word is "Trade". Economics is all about trading between different countries, and this is very important why we must all understand what is trading between countries means for us in trading FX. To illustrate my point, I will give a example of Singapore and Malaysia. The commodities here will be Pirated CD from Malaysia and New water from Singapore. The exchange rate will be 1SGD : 2RM. This example is not real and this is just for easy explanation only, who the hell needs pirated CD, but it is nevertheless a very important "commoditity" from our neighbour Malaysia.

The exchange rate is 1SGD : 2RM

Local prices for each commodity in each country.


@Singapore in SGD
Prices for Singapore traders, after converting malaysia prices from RM to SGD and comparing with local Singapore prices.


For Singapore traders
CD is cheaper in Malaysia then in Singapore. Singapore will import cheaper CD from Malaysia, selling them at Singapore to earn a higher profit.

Water is more expensive in Malaysia then in Singapore. Singapore will export New water from Singapore to Malaysia, selling them at Malaysia to earn a higher profit


@Malaysia in RM
Prices for Malaysia traders, after converting Singapore prices from SGD to RM and comparing with local Malaysia prices.



For Malaysia traders
Malaysia traders will find water cheaper in Singapore as compared to buying them at Malaysia. Malaysia will import New water from Singapore and sell them at Malaysia to earn a higher profit.

So therefore, a proftiable 2 way trade occurs between Singapore and Malaysia. Singapore import CD from Malaysia, export water to Malaysia. At the same time, Malaysia will import water from Singapore.

Ok everyone clear and understand what i just said? you need to because if you dont understand what i said eariler, then you surely wont understand what i am going to say next. so go and read what i just said on top again. if you are ready then lets proceed!



Money Value
If the money value of Singapore import of CD is equal to Malaysia import of Water, then we have balance trade. If not, the imbalance will cause the exchange rate to shift.

If Malaysia wanted 10 million worth of Water but Singapore is only willing to offer 9 million worth of water. The excess demand of Singapore Water and no supply causes the exchange rate to increase to maybe 1SGD :2.5RM, What will happen next is due to the shift in the exchange rate. Singapore water will cost more for Malaysia traders, and they will import less water from Singapore. At the same time, CD will become cheaper for Singapore and Singapore will import more CD from Malaysia.

How far can the exchange rate go? Are there any limits on its movement? The answer is that the range of the exchange rate movement can only move in a range that can offer profitable two way trading between Singapore and Malaysia. If both commodities were cheaper in Malaysia, then trade would only flow in only one direation: from Malaysia to Singapore. Lets take a closer look at this with numbers.





if lets say the exchange rate now change to 1SGD : 5RM
Here is the new price list for Singapore Traders



As you can see from the price list after the change in exchange rate. Now both commodities are cheaper in Malaysia. Singapore will import both commodities from Malaysia and thus one way trade will occur. From Malaysia to Singapore.


if lets say the exchange rate now change to 1SGD : 1RM
Here is the new price list for Singapore Traders



As you can see from the price list after the change in exchange rate. Now both commodities are cheaper in Singapore. Malaysia will import both commodities from Singapore and thus one way trade will occur. From Singapore to Malaysia.



I hope you understand what i just said because if we wish to be profitable in FX, we need to understand what we are dealing with. now as i mention eariler FX is economics and economics is internation interaction and trading. We say that the exchange rate must lie between the limits in which profitable two way trade can take places between the two countires. It is not like the exchange will not go beyond the limits in future, unless the economy of the countries we are trading completely crashed, we will not expect to see exchange rate going beyond the limits. Situations that would cause such a movement could not happen without people knowing about it.