The forex market is the most volatile, offering ample opportunities for forex traders to make substantial profits. Ever since retail forex traders were allowed to participate in the forex market, many have made huge profits by simply trading in that market. As the market does not sleep, many with their day jobs have the opportunity to participate and make a killing. Many left their day job and became full-time forex traders after witnessing astonishing success.
Although the forex market offers limited choices for trading, it is one of the easiest markets to learn. More than $7 trillion of daily traded volumes have been recorded in this market. It also offers leverage options that allow you, as a retail trader, to enter the market with a minimum amount of capital and maximize your profit potential. The forex market is also one of the most liquid markets, so trades are settled very quickly compared to stock markets.
If you wish to participate and make a living by simply trading in the forex market, you would like to know and understand what factors determine the price fluctuations of currency pairs. We have listed a few critical factors that are responsible for the price trend of a currency pair in the forex market.
Before you dive into the forex market, you must know that there are three basic types of currency pairs offered in the market. Major currency pairs, minor currency pairs, and, last but not least, exotic currency pairs.
The major currency pairs are the most preferred and quite popular with forex traders since they are comparatively more stable than the exotic currency pairs, which are highly volatile.
The volatility of a currency is based on the economic stability of the country’s currency in question. The more stable and developed the country, the more stable the currency’s valuation. For example, EUR/USD (the Euro-US Dollar currency pair) is more stable than USD/HKD (the US Dollar-Hong Kong Dollar).
Besides this, there are a few rules of economics that these currency pairs follow, which are responsible for their volatility. Understanding such factors can help you in your research while choosing a currency pair. As a beginner to forex trading, it would be wise if you stuck to your preferred choice of currency pairs, the major currency pairs.
Top Factors Affecting the Forex Market:
1. Interest Rates
The central bank of any country is responsible for the valuation of its currency. To benefit the country, its reserve bank will either value or devalue its currency to exploit the economic situation.
When interest rates are high, the country’s currency generates higher interest payments, resulting in more opportunities for profit growth.
However, if the rates are decreased, the opportunities to generate profits are decreased, thus, making them less valuable. Due to this, many are prompted to sell them off. As the demand for the currency in the market falls, so does its valuation.
2. Economic Stability
As we mentioned before, the economy of any country is the driving force behind the valuation of that country’s currency. Although demand and supply of the currency in the market are also among the driving factors, the primary factor is how good the economy is. Thus, such steps not only boost the economy of the country but also allow the foreign national company to become profitable.
A stable economy means ample opportunities for foreign investment to exploit the market, thus generating a lot of employment opportunities for the natives.
3. Trade-Weighted Index
A popular form of the effective exchange rate index is the trade-weighted effective exchange rate index (TWI), which is a multilateral exchange rate index. It is determined as a weighted average of domestic exchange rates versus international exchange rates, with the weight of each foreign country equal to its trade share.
When the exports are higher than the imports, it is a good sign from an economic point of view, since the country sells more compared to buying, thus, generating the overall profit of the country.
However, things are different if the country spends more by buying imports rather than generating more exports. The country becomes poor, and the youth of the country has to suffer as there are fewer employment opportunities. Since countries run on economies, they require money to run their internal and external affairs. A poorer country’s currency is unstable and valued less.
4. World Event
The strength of a currency also depends on geopolitical events, crises, and impending elections. If the country is in a constant state of war or is highly corrupt, and so forth, it creates a negative image in front of the rest of the world. No country would like to invest in a country where there is no growth, and the foreign country that is interested in investing in that country shies away for the fear of losing its money.
5. Government Debt
Government debt isn’t always a bad thing on its own. Local economic development and infrastructure can both be aided by it. When it rises too much, though, it might cause deflation and currency depreciation.
When the government’s debt is lowered, the economy becomes more stable, which draws in more investors and raises the currency’s value. Governments have been known to issue additional money to raise the amount in circulation as public debt levels rise (a practice known as quantitative easing). This lowers prices by eroding the value of current currency holdings.
6. Demography
If a country has a large youth population, then there are enough human resources available. An interested foreign country will always check the human resources available; thus, these companies do not need to bring in a workforce as it is readily available locally. Such an arrangement is beneficial as the country’s youth provides a workforce, thereby getting paid, further increasing and contributing to the country’s GDP (Gross Domestic Product) and the foreign company generates profit.
Conclusion
Several tools are available to forex traders to decipher the economic situation and exploit the market. Nonetheless, the trade secret of a successful forex trader depends on research, and strategizing to enter and exit a position.
As a beginner to the forex market, it solely depends on the efforts invested during the initial stage while learning the trade. Although making mistakes and suffering losses is fairly common while trading in the forex market, what sets professional forex traders apart is that they learn from their mistakes and ensure that they don’t repeat the same in the future.
