How the Forex Market Moves
How the Forex MovesHave you ever wondered about the machinations of the Forex, or foreign exchange market, and what drives it? That’s a question that many would-be traders consider every day, and attempt to answer so that they can profit from those moves. The complexity of the worldwide market, with trading happening from people around the globe, is truly difficult to unravel.
Firstly, for a trader who may be more used to stocks, you should realize what doesn’t move the Forex market. Particularly in penny stocks, but also with large investments in the shares of larger companies, stock followers are able to see the effect of large trading movements on the prices. This is an effect of the liquidity of a stock, that is, how large the market of buyers and sellers is, and consequently how easily the particular shares can be traded. Forex does not suffer from this deviation from a perfect market, as the amount of trading going on is enormous compared to any individual purchase. In fact, the volume of trading is about ten times the amount on all the world’s stock markets combined, and most of the trading takes place on just a few currency pairs – Forex trading is always associated with currency pairs, as, when you buy one currency, you pay for it with, or sell, another. Although there is no centralized exchange, it’s been estimated that the daily volume of trading in foreign exchange is over $3 trillion!
If trading doesn’t affect the prices, then what does? Well, as always, the market is driven by supply and demand, and the Forex market has the most exposure to all the global forces, and hence has the latest information from around the world factored in as it happens. There are several influences on supply and demand, however.
The primary influence on a currency’s value compared to others is the economic one. That encompasses how the country and its government are perceived by the rest of the world, which is intrinsically bound up in politics as well, but it is government policies that change the economic factors. An excellent recent example of this in the U.S.A. is the Federal Reserve changing the prime rate of interest. There are a number of ways in which these consequences are felt, and reflected in changing exchange rates.
Consider – the “Fed” has been lowering the interest rate. Its reason for this is to stimulate the economy, by making it easier for businesses to borrow money to operate and expand, and it is a standard response to what it sees as a recession looming. There are several consequences from this that have effects that are not so needed.
Firstly, the lowering in interest rate makes the dollar less desirable compared with other currencies which haven’t lowered their rates, so the public can choose to invest in other currencies, selling dollars. Supply and demand dictate that this will reduce the value of the dollar.
Secondly, the lowering of the rate makes inflation an issue, as it encourages spending that is not earned by work, but enabled by borrowing. Inflation generally reduces a currency’s value, as the spending power is eroded, and no-one wants to hang on to a currency which is losing its ability to buy. The Federal Reserve’s normal response to a threat of inflation is to raise the interest rates, to discourage excess spending, but in the current circumstances that is not considered an option, as recession has been established as the principal problem. Sometimes, perversely, the threat of inflation looming will increase the value of a currency, as the market expects that the interest rates will be raised to counter it, and this action is priced in to the exchange rate, despite not having yet occurred.
Other economic news affects the exchange rates. The gross domestic product, unemployment, retail sales, etc., in fact virtually anything that indicates, or the market thinks indicates, how healthy the overall economy is, can affect the exchange rate when announced. Politics can sometimes enter into these apparently definitive figures, as you will often see, for example, the method of calculating the unemployed numbers changed to reflect better on the current administration; or often there is a correction to the previous month’s figures issued with the new ones, which can lessen a detrimental impact.
Another influence on the exchange rate is the psychological one. A country considered to be solid may benefit from increased demand for its currency during a general unsettled period in world politics. Market traders can use fundamental analysis to seek underlying trends, which they can then follow with their trades. Technical analysis is used extensively by traders to try to spot patterns and signals for short term gains. Sometimes the cause of a move will not be apparent straight away, if ever. To help sort out the complexities of the Forex market, you need the advice of an expert such as Stu Whisson at Insight Support Limited, who offers a free introductory trading program at www.insightsupport.com .