The currency value in the forex market changes not only for the change in supply and demand of a currency. There are other factors that influence the forex market. Let’s see the discussion about the top 5 factors that influence forex markets from national and international perspectives.
February 24, 2020 | AtoZ Markets – The forex market is the world’s biggest and most liquid market. Therefore, any economic decision from a country may affect the overall forex market. On the other hand, the movement of the price relies on the supply and demand of a currency. Therefore, speculation is also a reason behind the price movement in the forex market.
We will see the top 5 factors that influence the forex market. If you are a forex trader, you must know these to keep yourself up-to-date about a particular economy.
The forex market is a unique place to buy and sell currency pairs, which represents a country’s economy. Therefore, the factors that affect the forex market may differ from other financial markets.
Why Forex Market is Unique than Other Markets?
When people think of investments, they think of the stock market. They think of trading stocks on the market to end up with more money at the end of the day.
However, some other people jump into forex markets to take the upper edge by breaking into unknown foreign markets. Still, there are many people who do not know about the forex market. Forex trading is a place to trade foreign currencies that is unique in multiple ways. Large Banks, Central Banks, Governments, and other financial institutions trade currencies in the forex market from most of the counties.
One of the unique features of the market is that there are a huge number & Variety of traders and trading instruments are available for trading. Therefore, traders from all around the world can diversify their portfolio by splitting their investment into many different currency pairs.
Another thing is that the forex market is available 24 hours a day. Therefore, traders can trade their favorite currency pairs at any time and from anywhere.
Next, comes the liquidity. In the forex market, there is about a $5.4 trillion US Dollars transaction that happens every day. So traders may see some fresh and solid price movements in every currency pair.
Another unique feature of the forex market is that traders can use many artificial bits of Intelligence in their trading strategy to make the trading activity automatic. This artificial intelligence works well in the forex market due to the availability of sufficient liquidity.
Who Runs the Forex Market?
The “Over The Counter” or OTC Interbank forex market consists of a loose and mostly unregulated cluster of financial companies. They often create charges per unit of quotations to buy. Within the Interbank market, the term “market maker” ordinarily refers each to the massive financial organization that creates prices to others
The larger among these monetary establishments generally act as market makers who provide forex rate quotes to every different, Interbank brokers. On the other hand, financial institutes, multinational companies, fund managers and high individuals are minor participants.
What are the Factors that Influence the Forex Market?
If you have read the above section about who runs the forex market, you probably did not see any name of retail traders. The influence of retail traders in the forex market is very tiny. The forex market is an international market. Therefore, the factors that influence the forex market are mostly related to a country’s economy.
Let’s have a look at the top 5 factors that influences the forex market
- Interest Rate Decision
- Inflation Report
- Political Stability
- Current Account & Terms of Trade
Let’s have a look in detail about these:
#1 Interest Rate Decision
By definition, an interest rate is a charge that the central bank takes from ordinary people to use its currency. Every central bank changes interest rates from time to time to meet their economic goal.
For example, the central bank will raise the interest rate if the money flow of the economy increases. On the other hand, the central bank will decrease the interest rate if they want people to take more money from the bank.
The overall interest rate decision is for the economy of a particular country. However, in the present day, one country depends on other countries. Therefore, an interest rate change from the US Federal Reserve or China might affect the global economy.
By changing the interest rate, the central bank can increase or decrease the value of a particular currency against other currencies. Therefore, we may see a change in prices in the Forex market for changing the interest rate decision.
#2 Inflation Report
Typically, a country with a lower inflation rate represents a rising currency value, as its purchasing power increases compared to other currencies. During the 2nd half of the 20th century, countries like Japan, Germany, and Switzerland were considered as a low inflation economy. Later on, the U.S. and Canada achieved low inflation status.
Countries with higher inflation rates usually see depreciation in their currency with their trading partners. This is derived by higher interest rates.
#3 Political Stability
Apart from economic factors, political stability affects the exchange rate of a country. Foreign investors usually prefer a stable political condition to make their transactions. Therefore, a stable and progressive government helps investors to get confidence while making an investment. Consequently, the inflow of foreign investment in the domestic economy makes the domestic currency to appreciate.
Apart from national politics, other factors like geopolitical uncertainty, global trade growth, corporate earnings, and business environment also affect the forex market.
The high-interest rate, high economic growth, and good corporate earnings have a positive effect on the currency. On the other hand, a high inflation rate, political instability, unstable government borrowings, and the uncertain geopolitical condition may cause a depreciation of the home currency.
Making money on the forex market is all about speculation and making an investment in currencies before increasing the value. Therefore, there are nice price changes in currency pairs without any fundamentals event. If investors believe that the Euro is going to gain its momentum against the US Dollar, the EURUSD price will move higher even if there is not a solid reason behind the movement.
#5 Current Account & Terms of Trade
The current account records the transaction of a country with its trading partners that include trade in both goods and services. The current account will show a deficit if a country imports more than its exports. The reason behind this is the demand for foreign currency is more than its supply. Therefore, the excess supply causes the domestic currency to depreciate.
Similarly, terms of trade is a ratio between a country’s export prices and its import prices. Favorable terms of trade often indicate that the export price realization is higher than the import price. Increasing terms of trade may indicate a greater demand for the exports of a country. Therefore, this will be positive for the home currency. Overall, rising terms of trade indicate an appreciation of the exchange rate.
All of these factors mentioned above influence the forex market most. If you are a forex trader or send or receive money from other countries, you can keep yourself up-to-date on these factors. It will help you better evaluate the optimal time to make an international money transfer or to take a suitable buy or sell a position in the currency pair.
In addition to that, the forex market in an international market and therefore, there are many risks associated with it. For retail traders, it is often hard to find the reason behind the currency move. Therefore, traders use different types of technical and fundamental analysis to anticipate the movement in a currency pair.
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