Every Tom, Dick and Harry knows that the foreign exchange rate for any given currency is bound to fluctuate over time. However, very few laypeople actually fully understand why currency exchange rates fluctuate the way that they do, and fewer still understand how.
If you're interested in getting into the forex market though, it is going to be in your best interests to at least have an inkling of an understanding as to how the pieces fit together.
To put it quite simply, the forex market, as with any ‘free’ market, operates on a strict principle of supply and demand. So if more people want a certain currency, and there’s not much of it floating around, then the value of that currency is high. Naturally, the opposite is equally true.
Understanding supply and demand is fairly easy, but grasping the fact that it is influenced not by one single factor is slightly more complicated. In truth, the forex market has 3 major factors at play, and they are:
1. Economic factors
Anything and everything that ties in with a country’s economy comes under this category, and it would include things such as the budget, financial policies, and also its trade figures and so on.
Really, there are a ton of factors at play within this one factor alone, and unless you’re an economist, it is unreasonable to expect you to know all of them. Suffice to say, a strong economy is essential for a strong foreign exchange rate.
2. Market psychology
Not everything about supply and demand is based on cold, hard, fact. Instead, a lot of it really does depend on what people ‘feel’. Sometimes, if people feel that the forex market is going to go wild, they may opt to switch their currencies to a ‘safe’ alternative, such as the Swiss Franc.
Naturally, this is going to affect the strength of that currency.
And remember: This is just one example of market psychology playing a role in the supply and demand of a currency.
3. Political conditions
Sometimes people consider this factor to be tied to economic conditions, and it is, in a sense. Tumultuous political conditions can weaken economies, and thus affect the foreign exchange rate.
However, changes in political conditions can be positive too, and if a party coming into power is deemed to be more sound financially, or more stable in general, it can help a currency gain strength.
Now that we’ve gone over the three main factors behind the forex, you should have at least a very basic idea of what is going on behind the velvet curtain. Also, you should now be able to even ‘predict’ the rise and fall of certain currencies based on current events, to a degree.
Practice makes perfect, so try to see if you can spot fluctuations before they happen! If you can, you’re well on the way to success!