Factors Affecting Currency Trading
Even if exchange rates are affected by numbers of factors, in the end, currency costs are a result of supply and require forces. The worlds currency markets can be considered as a massive melting pot: in a big and changing mix of current events, supply and demand ingredients are constantly switching, and the cost of one currency in relation to a second shifts accordingly. No additional marketplace comprehends as much of what is proceeding in the community at any given time as foreign currency exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic ingredients, political conditions and marketplace psychology.
Perhaps the most difficult to define (there are no balance sheets or income statements), market psychology influences the foreign exchange industry in a variety of ways:
Buy the rumor, sell the fact: This industry truism can apply to numerous currency situations. It is the tendency for the cost of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a marketplace being oversold or overbought.
Flights to quality: Unsettling international events can lead to a flight to quality with investors seeking a safe haven. There will be a greater demand, thus a higher cost, for currencies perceived as stronger over their relatively weaker counterparts.
Longterm trends: Very often, currency marketplaces move in long, pronounced trends. While currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longertrem cost trends that may rise form economic or political trends.
Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talismanlike effect the number itself becomes important to industry psychology and may have an immediate impact on shortterm market moves. What to watch can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
These include economic policy, disseminated by government agencies and central banks, and economic conditions, generally revealed through economic reports.
Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a governmentscentral bank influences the supply and cost of money, which is reflected by the level of interest rates).
Economic conditions include:
Inflation levels and trends: Typically, a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency.
Economic growth and health: Reports such as gross domestic product (GDP), employment levels, retail sales, capacity utilization and others, detail the levels of a countrys economic growth and health. Generally, the more healthy and robust a countrys economy, the better its currency will perform, and the more demand for it there will be.
Government budget deficits or surpluses: The market ususally reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a countrys curency.
Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a countrys currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nations economy. For example, trade deficits may have a negative impact on a nations currency.
Internal, regional, and international political conditions and cases can have a profound effect on currency marketplaces. For instance, political upheaval and instability can have a negative impact on a nations economy. The rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, cases in one country in a region may spur positive or negative interest in a neighboring country and, in the process, affect its currency.