The values of currencies on the forex market are impacted by the principle of Demand and Supply. Currency values are constantly in flux, regularly going up or down in value. Several years back, Gh¢1 was worth $5. At the time of writing, it is worth $12.30. This performance isn’t random but is attributed to a number of factors.
The Forex Market involves buyers and sellers all over the globe participating in trillions of dollars of trade each day. This means that Macro-economic events around the world play an immense role in the forex market. Hence, traders don’t have to stick to trading the popular currencies just because they are popular, anymore; knowledge of the factors that influence price movements in the forex market informs what and when to trade. In this article, we will discuss the key factors that influence price movement in the forex market to help you become a better Forex Trader
MACRO-ECONOMICS
Primarily, the forex market is driven by major macro-economic factors. These factors influence foreign exchange rates, ultimately determining a currency’s value at any given point. A country’s economic health plays an overarching role in the value, and by extension, the exchange rate of its currency. Just like any other financial market, investors put their monies into economies with a positive outlook and growth potential. Hence, indicators that point to this outlook or potential will boost investments and increase demand for the said country’s currency. On the other hand, a negative outlook harms investments and reduces demand leading to a fall in currency price. Current events and new information are able to quickly affect a country’s overall economic health. It’s therefore important to exercise discipline and stick to your Trading Strategy as news of events and current affairs trickle in, so you are not swayed off course.
CAPITAL MARKETS
Arguably, the most visible indicator of an economy’s health is the global capital market since it is easy to take note of the release of public information on capital markets. With the steady, 24-hour up-to-the-minute flow of media coverage on the affairs and activities of corporations, institutions, and government entities, a rally or sell-off of securities originating from one country or another, is usually a clear indication of the future outlook of that economy.
If you remember from our blog post – “Currency Trading and its 7 Pairs”, many economies are sector driven. Being a commodities market, for instance, the Canadian dollar is heavily correlated with commodities such as crude oil and metals. In effect, a rise in crude oil prices is likely to result in an appreciation of the Canadian dollar relative to other currencies. Commodity Trading similarly relies heavily on such economic data. The bond market and Treasury price fluctuations also affect price movement in the forex market, since fixed-income securities invariably rely on interest rates. Hence, a change in yields will directly affect currency values.
INTERNATIONAL TRADE
Another major factor that affects the forex market is the balance of trade between countries; the Balance of Trade (BOT) refers to the difference between the value of a country’s exports and the value of its imports at any given time. This forms the largest component of a country’s Balance of Payment, which is a statement of all transactions made between entities within a country and the rest of the world over a certain period. The trade balance serves as a representation of the relative demand for goods from a country; Thus, a country whose goods and services are in high demand internationally will typically have its currency appreciate in value. For instance, if you want to purchase goods from Japan, you will need to convert your money or whichever currency you hold into the Japanese Yen, and the increased demand for the Japanese Yen will lead to a rise in its value.
On the other hand, countries with large Trade Deficits – which occur when a country’s imports exceed its exports at any given period of time – need to sell more of their currency for that of the currencies they need, in order to purchase the goods or services of other countries. This situation unavoidably has a negative impact on the value of an importing country’s currency.
POLITICAL NEWS
Another major factor that results in forex market changes is political news. A country’s political landscape plays a critical role in the perceived value of its currency, and by extension, the movement of prices in the forex market. One thing Forex Traders constantly monitor is political news and events in order to anticipate changes in the economic policies of national governments. These may include a cut or an increase in government expenditure or changes in regulations relating to specific industries or sectors of the economy. Uncertain outcomes following elections, for instance, always affect the forex market. Exchange rates usually react positively to wins by pro-growth or parties that are perceived as being fiscally responsible. Major referendums can also affect price movement in the forex market; a typical example is the Brexit vote, which had a major effect on the British Pound.
In addition, the fiscal and monetary policies of governments in their economic decision-making, and central banks’ decisions that impact interest rates, also result in forex market changes.
ECONOMIC STATISTICS
Economic reports are the backbone of forex market changes. Gross Domestic Product (GDP) reports, which measure the total output of goods and services produced within an economy, for example, may present the most visible economic statistic, since this is the baseline of a country’s economic performance and strength.
Another significant factor affecting the forex market in terms of economic statistics is inflation. This is characterized by increasing price levels of goods and services, and relatively falling purchasing power. If country A’s inflation rate is relatively lower as compared to that of country B, the currency of country A is expected to appreciate in relation to the currency of country B, with a higher inflation rate. Inflation can be a double-edged sword; In many cases, it is seen to result in the depreciation of currencies, due to it lowering purchasing power. But inflation can also lead to currency appreciation in cases where it forces central banks to increase interest rates in their attempt to curb the rising levels of inflation; this increases the demand for the currency, resulting in increasing its exchange rate on the forex market. Thus, the effect of inflation on price movement in the forex market may not be as direct or straightforward but can move prices in the forex market either way.
Other economic statistics that affect prices in the forex market include employment levels, retail sales, manufacturing indexes, and capacity utilization. These carry vital information on an economy’s current and predicted strength and currency. They are able to provide confirmation of the main factors we’ve discussed above.
SPECULATION OR MARKET SENTIMENTS
This falls last on our list since it is not exactly a measurable factor; In its simplest, yet extreme instances, greed can turn a rising market into a blind-buying spree, and fear can turn a falling instrument into an all-out panic. If there’s speculation, or simply a feeling that the value of a currency will rise, for instance, investors will demand more of the currency, and its exchange rate in the forex market increases further. The reverse is true – If there’s a certain feeling that the value of a currency will drop, the demand for the said currency drops, decreasing its value in the forex market. Once people begin to get a sense that a currency price is moving in a certain direction, people begin to buy or sell off the currency based on this speculation.
In conclusion, forex market changes are ultimately driven by economic and political factors that impact the strength and in effect, the value of a country’s currency. Certain unforeseen factors such as natural disasters and acts of terrorism also affect prices in the forex market. As explained above, a country’s economic outlook has the strongest influence on the value of its currency. Knowing about these factors will help you with the indicators to watch and enable you to keep pace in this competitive and fast-moving world of Online Forex Trading
Brought to You by Geldex Invest on behalf of Growell Capital.