Forex market and its prices are a mystery to most new traders.
Questions such as, ‘what causes currency prices to move?’, ‘who decides whether one currency should appreciate in value or depreciate?’ are common on forex trading forums.
It is to answer these very questions that this piece is being written. So let’s get to it.
Factors affecting currency value
There is no straight forward answer to this question. We need to address it at two levels if we’re going to get to the root of it.
First level of factors
The first level is the body that analyzes the market and comes to the conclusion that currency A should increase in value. This body is comprised of all the participants of the foreign exchange business.
Everyone who is participating in the market in one way or the other contributes to the eventual direction the market takes. After all, in forex, the traders are the market.
Forex as an OTC market
Traders and the market participants are especially important in forex because it is an OTC market. OTC stands for Over The Counter and it means that there is no central exchange. There is no regulatory authority keeping an eye on the workings of the market or that strategizes for it.
In forex, anything goes as long as enough participants actively trying to make it happen.
This is one of the reasons why we also maintain that forex cannot be rigged. It’s because there is no one in charge of it to rig it. That, however, is a topic for another time. For now let us focus on price moves.
Now that we know that people can do what they like, is there a way to show their decision about the future of a currency? Yes, there is.
Manifestations of currency analysis in the market
If a group of traders believes that the Japanese Yen (JPY) is going to increase in value, and that group is large enough and influential enough, they will drive the JPY up.
Similarly, if a group of traders (a group that is strong enough) believes that the value of JPY will depreciate, they will bring the price down.
How is a currency’s value driven up or down? By manipulating supply and demand.
Supply and Demand
We have discussed this idea in other blogs too but we will go over it briefly here as well.
Supply is the amount or volume of a currency available in the market. This is the amount that is available to be bought. In other words, it shows how many sellers are present in the market and willing to part with that currency.
Demand, on the other hand, is the amount that is needed in the market. This is the amount that the market is ready and willing to buy. In other words, it shows how many buyers are present in the market and willing to acquire the said currency.
These two are inextricably linked to each other and the value of a currency. So when the supply exceeds demand, it means that there are more who are willing to sell than those willing to buy. It shows a lack of interest in the currency. This lack of interest translates into depreciated value of the currency.
Similarly, when the demand exceeds supply, it means that there are more who are willing to buy than those who are willing to sell. It shows the market’s interest in the currency and the traders’ willingness to acquire it and keep it. This great interest translates into appreciated value of the currency.
So, when the value of JPY goes up, one of the biggest contributing factors is that the demand is exceeding supply.
If you have read up a little on the forex market, you will know by now that nothing is this simple in forex. There is always a plethora of reasons that lead to a trend forming. Therefore, supply and demand too forms only one of the causes.
Supply and demand are the result. What are they a result of? It can’t be that a trader wakes up one morning and thinks the CHF is probably going to grow in value today and base their trades off of that notion.
There has to be something that informs the analysis that leads to an increase in supply or demand. What could it be?
Factors that inform the analysis
In one word, it is information.
Ultimately it is always information that tells what direction a currency will take. This information reaches the traders in the form of:
- Interest rate reports
- Economic data such as Consumer Price Index, Employment rates, GDP (Gross Domestic Product), Average Earnings etc.
It is all this information, that you can have from economic channels or the paper, that tells you which direction that currency is headed.
The regular reports such as Non-Farm Payrolls etc. are waited for. This means that when the NFP comes out, you can be sure that it will have some kind of an effect on the market.
Staying up to date with this kind of economic data and understanding how the numbers affect the value of that country’s currency, are incredibly important analytical skills for forex traders.
You can’t base your decisions on someone else’s analysis. Knowing the basics of economics and the effect of changes in central bank policies on the standing of the currency will form the foundation of your analysis.
Forex offers a world of opportunity to those who understand the market and can make the right moves at the right time.
The market will either go up or down, it is you analysis that will decide what side you are on when the trends form. Staying one step ahead in your analysis will mean that you are prepared for any major moves in the currency value.
You might want to get your hands on sources that will provide you with data reports. If you can find a good one, they will also give you a brief analysis of what it means for the currency.