Factors affecting the Forex market and what causes the Forex market to move
BY Chris Andreou
|January 6, 2022Do you want to know what Forex traders consider when they’re making their trading decisions? I’ll tell you what causes the Forex market to move with this list factors that affect currency prices.
If you are currently trading or planning to get involved in the Forex market, it’s essential to know what makes currency prices move. You need to know what factors affect currency prices so you can be ready when things change.
It’s no secret that the Forex markets have some of the most significant price swings in the world and you need to know why currency prices change so much. Exchange rates and prices are affected by one overarching reason and that is influenced by many different factors. Stick around until the end to learn what they are.
So without any further delay, let’s get started.
What causes the Forex market to move
Not that surprisingly, the health of a countries economy can have a direct effect on the value of its national currency. When economic growth is strong and unemployment is low, investors are more willing to take on risk by investing. Consumers are also more willing to spend money as they are optimistic about their potential earnings.
Conversely, when economic growth is weak or unemployment is high, investors and consumers tend to become pessimistic about the future. This causes them to shy away from making riskier investments and spending money.
Any economic development that can affect the global economy or an individual country will likely cause currency prices to move. However, some economic indicators have a greater impact on the forex market than others.
Let’s take a look at some of the most important ones.
Gross domestic product (GDP)
GDP is one of the most important drivers that causes the Forex market to move. It is a measure of the total value of goods and services produced within a country during a given time period.
Whenever this economic data is released, it provides information about how strong or weak an economy is doing and traders take their cue from it.
Retail sales
Retail Sales is the volume of sales in stores and restaurants and indicates how much consumers are spending. The retail sales figures are an important factor affecting the Forex market, because consumer spending is a primary driver for economic growth.
When consumers are confident about the economy and the security of their jobs, they are willing to save less and spend more.
Employment data
However, when unemployment is rising and there is a lack of job security, consumers are reluctant to spend or spend less. The government also receives less in taxes and even spends more on unemployment benefits and social welfare.
Employment data is directly correlated to the health of a countries economy. Traders watch this economic indicator carefully as it is one of the biggest factors that causes the Forex market to move.
Consumer price indices (CPI)
The CPI is a measure of the average price that consumers pay for various and necessary goods and services. It can also be used to make the comparison between the current cost of living and the cost of living from previous years.
Rising consumer prices, otherwise known as inflation, leads to loss of purchasing and spending power. CPI affects economic growth and whenever this economic data is released, it usually causes the Forex market to move.
Central banks also closely monitor inflation to help them enact monetary policy to manage the money supply and the economy.
Use the financial calendar to know when these events will occur. It shows what economic data is being released and when it will be released. It also indicates to traders the severity of the potential impact it will have on a currency. Check the financial calendar as these events usually causes the Forex market to move.
Central bank policy affects the Forex market
Speak to any trader and they’ll tell you that the Forex market is affected by a combination of fundamental and technical factors. While these often influence the Forex market, central bank policy can be an overriding factor that causes the forex market to move.
Central bank policy refers to both monetary and fiscal policies by a country’s central bank (or reserve bank). The main objectives for any central bank are maintaining price stability and promoting economic growth in their country. Price stability means keeping inflation low, while economic growth means increasing investment and employment opportunities to increase wealth creation. Their main tool to achieve this is interest rates.
Lower interest rates generally make a country’s currency less attractive because investors will want to invest in higher-yielding assets elsewhere in the world. However, it encourages loans and spending and weakens the nation’s currency making exports more attractive.
Higher interest rates have an opposite effect. They encourage savings, discourage loans, and make exports less attractive but control inflationary pressures.
Interest rates are very important in Forex trading because they have a direct effect on currency prices. Whenever a central bank raises or lowers interest rates, it causes the Forex market to move and influences traders to readjust their positions.
Speculation by big investors and large commercials
There are many reasons why prices move up and down in the Forex market on any given day. Even though the market is open to practically anyone, there are typically two groups of people that affect the Forex market the most. Primarily through their huge buying power, these are the large speculators and commercials.
You can follow their open interest and positions in the market to help you make better informed decisions. The Commodity Futures Trading Commission (CFTC) publishes a commitment of traders report so you can see the dynamics of their activity in the market.
Although this only includes data for open positions for Forex futures, it can be used as a proxy of their sentiment and positions in the spot market.
These two groups are usually diametrically opposed and observing their activity and how it affects the price of currency can give you clues for your own trading.
Political and geopolitical events
Tied in with global economic events, the political and geopolitical landscape has factors that affect the forex market, such as when elections or potential changes in leadership are due. A change in leadership generally ushers in changes that can affect how a country runs its policy. This typically causes the Forex market to move and the impact can be quite dramatic.
For example, the BREXIT referendum in 2016 had a major impact on the value of the GBP. When British constituents voted to withdraw from the European Union, a political earthquake was ignited across financial markets. We saw the GBPUSD devalue by about 1800 pips in a single day and caused the whole Forex market to move.
Disruptive times bring turbulence to the Forex markets, and currency prices respond to world events outside of what is normal too. As another example, when the corona virus outbreak became a reality in 2019, it spread globally and created a worldwide pandemic. Governments reacted to slow the spread of the virus by imposing isolations and economic lock downs, disrupting economic activity, global supply chains and people’s lives.
This is one of the most recent and significant causes that affected the Forex market and financial markets in general saw major repricing’s to factor this in.
Natural disasters affect the Forex market
Natural disasters have a huge impact on currencies, as risk-averse investors flock to safe havens such as the US dollar, which can make a currency spike or plummet in price.
The key to understanding how natural disasters affect currency prices is to see how these events affect a nation’s economic activity. They can lead to disruptions in transportation and logistics; require costs for the rebuilding process and possibly causing higher inflation.
Depending on the severity, natural disaster can damage infrastructure, which affects economic activity. This can lead to changes in financial market conditions, including exchange rates.
Technical indicators and price levels
While trading currencies, you will notice these wide ranging factors that affect the Forex market. At the same time, traders have their own strategies and trading methods to help them predict price movements.
How traders interact with the information they receive from the market causes the Forex market to move. Traders usually look at things such as order flow, and significant price levels of interest to determine their buying and selling activity.
You can see this in action for yourself, a simple thing you can do is open a chart of your favourite currency pair. Mark off the major big round numbers such as 1.3000, 1.3100, and 1.3200 for example, and observe how price reacts around these levels. You might usually see short, medium and longer term price reversals around these price areas. Other traders are watching these price areas too, to help them make their buying or selling decisions.
Although the affect is not significant on the individual level, the collective action accumulated at scale can shift the supply and demand dynamics in the market place. Especially, when the large speculators and commercials decide to get involved.
Sentiment and price trends
What is going to happen to the Forex market next? This is a question that every trader asks themselves often. As you are probably discovering by now, answers to this question can be complex and hard to analyse.
With that said, the value of a currency is mainly determined by the demand for it. If there is a lot of demand for a currency, the price should trade higher than it would if demand for it was low. Likewise, if there is a lot of supply for a particular currency, the price should trade lower.
Over time, this creates price trends and changes in sentiment that further influences the psychology of market participants. Especially the large speculators and the commercials mentioned above. Once they get behind a move, either to speculate or due to a commercial necessity, they can cause the Forex market to move.
Sentiment analysis allows us to approximate what the market thinks about it all. With that, traders can make their buying and selling decisions, adding to the supply or demand side of the marketplace.
You can see TIOmarkets clients' sentiment and positioning on our forex dashboard.
Conclusion
Most investors and traders know that economic and political events can affect the price of currency pairs. Economic data includes things like GDP, inflation, unemployment figures and retail sales. These data points are important because they can influence central banks’ decisions regarding interest rates.
Political events are other factors that affect the Forex market, as they give traders new dynamics from changes in policy to consider.
Further to the immediate reactions in the market from economic data and political events, there is also the unexpected to take in to account. Natural disaster can have devastating effects on a country’s economy. Transportation and logistics can be impacted, disrupting supply chains. The rebuilding process takes time and has costs involved too, which can impact the national currency.
Trying to understand the factors affecting the Forex market might help you predict future price movements. If you understand why a currency is being sold or bought, and you also have an understanding of what factors affect the Forex market, you can predict future price movements better. Human emotions are the number one factor that stirs up the Forex market and you have to think, how will this affect the supply or demand for currency.
With some study, observation and practice, you can use these factors to help you anticipate and predict future price moves in the Forex market.
To start, check the economic calendar for the next high impact economic data release and watch how this affects the Forex market. Consider opening a demo account to practice or register a live account to trade with small amounts.
Register your trading account here.
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