Forex (Foreign Exchange) is one of the most popular trading categories for the online trader. It has recently been reported that up to $4 trillion dollars is traded on global Forex markets daily (this excludes the trading of Forex based derivatives). This makes it one of the most active markets in the world and is particularly attractive for traders as Forex markets are open 24/7 with the exceptions of weekends. Many people are interested in trading Forex but are unsure as what actually drives the fluctuations found in the Forex markets, today we are going to examine some of the factors that drive movements in the international foreign exchange markets.
Speculation
By far the biggest factor in the daily movements in the Forex market is pure speculation unrelated to underlying economic conditions. Some have stated that around 70% of all Foreign exchange trading is speculative, with major international hedge funds rise to prominence in the 90’s playing a significant role in the rise of currency speculation. While it is hard to gauge which way speculation will take a market, it is possible to use speculation to your favor when trading Forex by surfing the underlying speculative trends.
Political Conditions
Political conditions and even the political party in power can have an effect on movements in the Forex markets. Political stability is crucial, no right minded investor wants to hold the currency of a nation suffering from significant political instability due to the inherent risk that political instability holds. Real life examples where major currencies have suffered significant negative movements in currency valuations are plentiful. In recent history unstable governments in Thailand have had a significant downward effect on Thai currency prices. 2012 might see political instability in Russia also lead to a drop in the strength of Ruble, though such a movement will also be linked to capital flight out of Russia.
Inflation
A currency of a nation which is either struggling with inflation or seeing significant increases in inflation will typically see a decrease in the strength of the currency. This is due to the relative buying power of the currency decreasing. Though sometimes inflationary pressure will lead to the expectation that the central bank will take action and raise interest rates to combat inflation, this expectation can in fact lead to a rise in the price of the currency.
Economic Growth
One of the more obvious factors that effects the movement of currency prices. Generally a healthy economic outlook means that there will be strong demand for the currency and this will have an effect on strengthening the currency. Economic growth also attracts investment from outside sources meaning there may be a strong flow of capital arriving into the country.
Government Fiscal & Monetary Policy
Governments use of fiscal and monetary policy can effect the price of currency. Typical a rise in interest will see hot money enter the country and strengthen the currency, while a lowering of interest rates will lead to money leaving the country in order to look for opportunities to earn greater interest. Monetary policy also plays a role as this can effect the money supply and can have complicated effects on the value of the currency. For example working out what the effect recent bouts of Quantitative easing will have on the currency prices has been difficult. In one way QE raises the chance seeing higher rates of inflation (a downward pressure on currency) but at the same time should stimulate positive growth in the short term. It can also be noted that Government efforts in controlling currency values have been terribly ineffective in recent times, with the belief governments could really control currency prices being crushed by Black Wednesday in 1992.
Government Deficits and Trade Balances
Unsurprisingly large Government deficits, negative and worsening trade balances have a negative effect on currency prices. These indicators often reflect trouble for the economy as it shows imbalance and also shows a lack of international competitiveness. Of course positive trade balances and government balances have the opposite effect leading to strengthening of the currency on international markets.
Psychological Factors
Market psychological factors can also play an important role. Many of those trading on the Forex markets will be either knowingly or unknowingly effected by these psychological factors. These factors include flight to quality during international scares, long term trends and market rumors.
