If you are a day trader and you watch the Forex markets, you would be completely justified in asking what makes the currency markets move. Broadly there are 7 main reasons.
1. No idea! Despite everything you have read on economics and all the fundamental financial data, the truth is many FX moves make no sense at all. They are counter intuitive, they are illogical and they are frustrating to those who are trying to analyse the markets.
This may be a completely unsatisfactory answer to those of you pouring over the financial newspapers and watching the business channels. Nevertheless there is a percentage of market moves which appear to be totally random.
2. Currencies are just the same as anything else in the market. They are driven by supply and demand. If lots of investors want to buy the US dollar then the value will go up. If they don’t want the Yen then it will fall.
Of course a falling market offers the trader the chance to short the market.
3. Currencies become stronger or weaker in relation to the interest rates of the various countries. At the time of writing, the Australian prime interest rates were much higher than the US rates. This means that money flows out of the US in to Australia. Therefore the Aussie dollar strengthens and the US dollar weakens. This can apply between any set of currencies.
4. Economic factors and economic data release can have an immediate effect on a currency. If the unemployment rate falls then the currency can spike up, if the news is bad then the currency can fall.
Response to economic news can be short and sharp. The market can over react and then it usually self corrects soon afterwards.
5. Currencies react badly to political instability. This is not rocket science. Look around the world, anywhere there is political upheaval there is usually currency weakness. We all like certainty and markets are no different.
But even a stable political environment such as the US can have difficulties when they print money like there is no tomorrow to support their lagging economy.
6. Natural disasters are another problem, again there is uncertainty. The ability of a county to pay for their reconstruction programme may cause traders to abandon that currency.
It can also transpire that if a wealthy nation generously gives aid it may be perceived that that country is going to be under increased financial pressure as a result of their humanitarian nature.
7. Terrorism is a direct threat on a countries currency value. In fact it is argued in some circles that the economic impacts of a terrorist act are just as devastating and perhaps the economic stability was actually the intended target.
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Happy Trading
Ian Newton
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