Understanding the market

What moves the price and why?

Being the largest financial market in the world, Forex presents many opportunities for traders looking to make profits on the price fluctuations that occur each day. This is done by simply selling your currency for higher than your buy price if you are buying, and vice versa if you are selling.

The key to success in trading is consistency. It is vital that traders can routinely forecast market movements with high accuracy and post winning trades whilst keeping losses to a minimum. 

This plays down to one major factor, market understanding. If we know how and why the market moves, then we can more easily predict these movements and eventually profit from them.

Supply and demand

Like all markets, forex is at the mercy of simple supply and demand economics. If there are more people buying a currency then there are selling, then that currency is in demand and the price should rise.

Conversely, if there are more people selling than there are buying, then the currency has a lower demand and the price should fall.

Note: This is with the assumption that supply remains the same throughout.

Let’s break this down even further.

What is driving demand?

Demand for a currency can be driven by the perceived prospects for the currency’s nation as a whole. This is, of course, an extremely complicated set of factors that are very hard to break down, however, there are two main areas of focus.

One of them being the political landscape of the country at present and the other being the conditions of their economy.

In general, if these factors are considered to be positive, then demand will increase. If they are negative, then demand will fall. There are many factors that can come into play here, and some currencies are more sensitive to political news while others to economic.

As a very general rule of thumb, the most popular currencies with the highest trading volumes are more sensitive to economic data than the political landscape. This is due to the fact that the nations of these currencies are usually quite stable and would not be too affected by political news. Of course, this is not always the case.

What causes currencies to fluctuate?

As we touched upon, there are many things that may cause the market to fluctuate. Here are the main areas that

Interest Rate Changes

One of the biggest factors affecting the forex market is interest rate changes that are made by the central banks, specifically the eight global central banks. When these banks change their interest rates, it can lead to sudden and very volatile price changes.

Generally, central banks will raise their interest rates in an attempt to stifle the inflation of their currency. On the other hand, they will normally cut rates to try and stimulate their economy and by encouraging banks to lend.

If an interest rate in one currency is higher than in another, then that usually generates demand. The higher the interest rate, the higher the rate of return is and the higher the profit.

Economic and Political News

As mentioned earlier, the economic and political news can be huge factors in driving demand.

Some of the main factors influencing price include; the consumer price index (CPI), retail sales, quantitative easing, gross domestic product (GDP), and employment rates.

These are all big indicators to the health of a countries economy and its stability.

Trader/Market Sentiment

When it all boils down to it, it is really the institutional investors and traders that will move the price most heavily. Sometimes, all the political and economic news can suggest that the market will move in one direction yet the price does the opposite.

While this is unlikely, it is by no means rare.

As we will touch upon heavily in this course, there are many technical indicators that present buy and sell signals that a lot of traders will be reacting to. This creates massive intraday trading opportunities for short term scalps and profitable day trading positions.

In these short term instances, the political and economic landscape of the currency’s country does not hold as much weight – in other words, the macroeconomics become less important. When we look at shorter time frames, it is better to have one eye on the fundamentals while paying closer attention to the market trends, support and resistance, moving averages and other technical indicators that can help determine the future price movements.

As this course goes on, we will go into much greater detail on these topics and will discuss technical analysis in Units 3 and 4.