Factors Affecting Currency Trading
Exchange rates are affected by many factors; however, the most important and influential is a currency’s (based on a country’s exporting of goods) supply and demand.
The currency markets of the world can be viewed as a wide ranging and constantly changing mix of current events. Due to the volatile nature of current (and world) events and the constant shifting of supply and demand, the price of one currency in relation to another is always changing. No other market is affected so much by what is going on in the world as much as the Forex.
Supply and demand for any given currency (its trading value) are influenced by several factors. These elements generally fall into three categories: political conditions, economic factors, and market psychology.
National and international political events and conditions can have a significant effect on regional currency markets, as well as the Forex market as a whole.
As would be expected, times of political turmoil and instability can have a negative impact on a nation’s economy. On the other hand, if a nation instills a new government deemed “economically friendly,” favorable economic and trading conditions may result.
Economic factors include governmental economic policy and economic conditions, as seen in a nation’s public records and economic reports.
Economic policy includes government sanctioned fiscal policy, such as budget policies, spending, trade, and monetary policy. Monetary policy is ultimately controlled by a nation’s central bank and includes interest rates and the supply of currency.
Economic conditions include the following:
- Deficits and surpluses: Simply put, the wider a nation’s deficit, the lower its currency and trade value will be.
- Trade levels and trends: The higher a nation’s trade levels, the higher the demand will be for its currency to perform these trades, thus increasing the currency’s value.
- Inflation: Characteristically, the higher a nation’s rate of inflation, the lower the value of its currency.
- Economic figures and reports: Reports such as GDP (gross domestic product), unemployment (and employment) levels, sales of goods, offer insight into a nation’s economic growth and health. Commonly, the more healthy country’s economy, the better its currency will perform, resulting in a higher demand for it.
Market psychology influences the Forex market in a variety of ways:
- Economic figures and reports: Economic figures that Forex investors pay constant attention to include, inflation, money supply, (un)employment, and trade figures. Also of importance are a country’s economic reports outlining GDP (Gross Domestic Product), GNP (Gross National Product), GNI (Gross National Income), NNI (Net National Income), NNP (Net National Product).
- “Flights to quality”: Troubling international events can lead to what is called in the Forex market a “flight to quality.” This flight from an “uncertain” currency leads investors to seek a “safe haven” currency. The Swiss franc is a good example of a safe haven currency (due to their known neutrality and stability) during times of political or economic uncertainty.
- Long-term trends: Although currencies do not have clear growth trends like stocks and commodities, they do often move in visible long-term trends. Cyclical trend analysis looks at longer-term price trends that may rise from economic or political trends.
- “Buy the rumor, sell the fact”: A popular market maxim, it can apply to many to the anticipation of a particular action happening and reacting (with a trade or another transaction) in exactly the opposite direction. This is also referred to as the market being “overbought” or “oversold.”
A controversial topic and practice, speculation is the method of investing in currencies with a higher risk in order to profit from an anticipated (and usually large) movement in price. Currency speculation has become suspect activity in many countries. Many financial experts and corporate executives feel that speculation is merely “informed gambling” who can have a negative effect on a nation’s economy and the Forex market. According to Gregory Millman, author of The Vandal’s Crown: How Rebel Currency Traders Overthrew the World’s Central Banks, speculators are “vigilantes” who help “enforce” international trade and anticipate the effects of basic economic policies in order to increase their profits. While there are well-known individual speculators, hedge funds represent the majority of speculators with the power to influence the market.