How to read Market Movements for more accurate Forex Trading
How much money you make as a foreign currency trader will largely depend on how skilfully you can predict movements in the Forex market. So the question is, What are the key factors that will cause your chosen currency’s rate of exchange to change? Here are some pointers to help you with that.
When a country’s economy is strong, the central banks of that country will often raise interest rates in order to keep inflation in check. The resulting increase in interest rates, inevitably produces more movement in that country’s financial marketplaces and with the influx of this increase in activity comes an increase in demand for that country’s currency – and it’s this demand that pushes up the exchange rate, the same way as a run on petrol, for instance.
When a country’s exchange rate goes up, interest rate will climb along with it. Traders then have the opportunity to buy currencies from countries that have high-interest rates and finance these purchases with currency bought from countries with low-interest rates. This kind of activity will also cause foreign exchange market movements.
If, for instance, there are figures released showing a worsening in unemployment, investors may reasonably predict that the Bank of England or FED might drop interest rates to encourage growth. As interest rates are closely attached to a country exchange rate, this kind of anticipated action could cause a depreciation in the country’s currency.
The simplest explanation for this depreciation is that a decrease in the short-term interest rate means future investments in that country will be worth less because in the short-term at least the return will be less.
And with a drop in perceived value comes a drop in demand and therefore the country’s exchange rate. At the same time as this is happening investors will liquidate their US dollar investments in favour of higher paying yields.
As a trader, to take advantage of this depreciation you would buy, say, Euros before it actually happened in order to take advantage of the relative increase in value of the Euro (or whatever country is climbing against your country’s currency).
But let’s say you predict that the interest rate will not fall as poor employment figures are announced. On the day everyone learns the interest rate has remain unchanged, those people who acted believing there would be a drop in the currency now buy back their currency. Supply gets tight, the exchange rate appreciates and you stand to profit. If you’d been canny enough you could have bought more of your foreign currency and you would have made an even greater margin for your trade, simply through sticking to your prediction that the Bank would not lower its rate.
Wars, both political and real, also cause movements on the foreign exchange. For instance, when Greece got into steep trouble with its debt repayment programme, the pound rallied against the Euro.
Trade and capital flows will also affect the exchange rate of a foreign currency. Generally speaking traders will read a worsening trade balance as sign that the country’s exchange rate is prone to depreciation, and that it is more likely to appreciate if the balance of trade is favourable.
The Balance of Trade is important to a currency trader because export demand and currency demand are inextricably linked. Foreigners must buy the domestic currency to pay for that country’s exports. So, the stronger the exports in any given month, the greater the demand for the currency of that country. A rise in exports can also push up prices of parts etc., as domestic manufacturers strive to meet the increase in demand by increasing production.
Clearly a change in the balance of payments from one country to another has a direct effect on currency levels. Therefore, it is important for traders to keep abreast of economic data relating to this balance and understand the implications of changes in the balance of payments.
When capital flows – money sent from overseas in order to invest in foreign markets –exceed the investments that are leaving that country for foreign sources, there is an increase in demand for more of that country’s currency, because an investor must convert his currency into that of the domestic currency in order to fulfil his investment.
Conversely, if there is a negative capital flow, there is less demand for that country’s currency – and because the investor must sell his local currency to buy the domestic currency where he is depositing his money, his currency will begin to depreciate in value.
This is why countries with a positive capital flow, like the UK right now, maintain a strong exchange rate.
Just from these simple pointers you can see how these various market movements can affect the profitability of your trades. So, always keep an eye on the bigger picture!