- Summary:
- The exchange rate of a currency is primarily influenced by the state of the respective economy, which may change as result of current affairs.
Table of Contents
The foreign exchange market, also referred to as the forex market, is the largest financial market globally and one of the most fluctuating. The process of converting one national currency to another for the purposes of trading, tourism, investments, and commerce is impacted by a broad range of factors. Open round-the-clock, five days a week, the forex market is extremely fast-paced, and its average trading volume has been estimated at $6.6 trillion per day.
Currency Pairs in the Forex Market
The forex market enables buying, selling, exchanging, and speculation of various currency pairs. Much like all markets, the forex market is impacted by the interaction of supply and demand. If, for instance, a trader suspects one currency’s strength will be boosted against another, and demand will increase, they would buy that currency pair. Conversely, in case they believe it will weaken, they would sell.
Besides the major currency pairs such as EUR/USD, USD/JPY, GBP/USD, and USD/CHF, there are many other minor pairs, exotic pairs, and regional pairs. Although traders do not have to adhere to popular currencies only, they are a good starting point to consider.
The factors impacting currencies’ fluctuations vary, and this guide examines the most significant ones. Figuring them out is the key to making knowledgeable and profitable Forex decisions while keeping losses to a minimum.
What Impacts the Forex Market the Most?
As there is not a specific set of factors that govern exchange rate fluctuations, we can classify the major ones into three groups:
- Economic factors
- Influence of international trade
- Global events, including geopolitical events and natural disasters
Economic Factors
The exchange rate of a currency is primarily influenced by the state of the respective economy, which may change swiftly as a result of current affairs. Based on the economic performance of a nation, exchange rates go up or down. Economic health is closely intertwined with other important factors such as the Gross Domestic Product (GDP) of a nation, rates of unemployment and inflation, as well as the volume of foreign investments.
The GDP is an indicator of the market value of all products and services produced within a country for a certain period. It is fundamental to a country’s economic performance. As far as inflation is concerned, countries with low inflation have stronger purchasing power; hence a stronger currency than countries with higher inflation rates. Low unemployment rates also contribute to a strong purchasing power.
International Trade
Yet another crucial factor that affects the forex market is international trade. The balance of trade between nations directly influences currency exchange rates. The higher the demand for the products or services that a country puts forward, the more highly appreciated its currency will be.
For example, buyers must convert their funds into New Zealand dollars (NZD) to purchase goods from New Zealand. Consequently, the high demand for the New Zealand dollar will positively affect its value. Conversely, a country’s high volume of purchased foreign goods is likely to adversely impact its currency.
Global Events
The influence of foreign affairs and various geopolitical events of varying prominence should not be underestimated. Examples of such events might be elections, referendums, and military conflicts. Nations actively involved in war tend to experience greater currency fluctuations than nations at peace. Conversely, politically stable countries naturally draw a greater volume of foreign investments, which in turn helps to decrease inflation and strengthen their currencies.
Other than the human factor, we should also point out the importance of natural disasters and their immediate effect on a country’s citizens and infrastructure. As one may easily suppose, natural disasters such as floods, hurricanes, and earthquakes would also depreciate a nation’s currency.
Final Thoughts
The growth or decline of the various factors has a significant bearing on a particular currency value. Therefore, by staying tuned to the various economic factors and the latest news and having a good grasp of how global economies are correlated, it is easier to spot Forex opportunities and pinpoint the most suitable time to trade.