Crucial Factors That Affect Exchange Rates

Jesse Livermore, widely considered the greatest trader of all-time, once said, “I learned early that there is nothing new in Wall Street … Whatever happens in the stock market today has happened before and will happen again.”

The same can be said of forex markets. The problem is that it can be overwhelming trying to monitor all the data, current events and political news related to the countries whose currencies you intend to trade. There are a few basic factors relating to the economic health of countries that you must understand and monitor if you hope to be a successful trader. Below I have outlined five of the most important.

Politics

Any change in the political landscape of a country can have a major impact on its currency. As the old saying goes, “perception is reality.” So, while the actual long-term impact of a political change may be small, the day-to-day to value of a currency can be significantly jolted by rumours of war, natural disasters, major policy shifts (i.e. Brexit) and elections. Monitoring current events in the countries of interest is a good practice, especially if you are trying to make short duration trades.

Rate of Inflation

A primary economic indicator to track and gauge as a trader is the rate of inflation. A currency experiencing rising inflation will see its value drop in relation to others. A high inflation rate is likely to have a negative impact on exchange rates with other nations. One thing to note is that inflation is measured as a rate of change — not as an absolute change in prices. This means it is possible for prices to rise while seeing a lower overall rate of inflation.

Interest Rates

Closely related to the rate of inflation are interest rates. When trading currency, we are concerned with the interest rates set by the eight global central banks. These rates are set in response to other national economic indicators, including the Consumer Price Index, consumer spending, employment stats, and the housing market. Once changed, they can have an immediate and meaningful impact on markets. Following economic indicator trends over time can also aid traders in taking forex positions.

Monitoring the many factors that drive exchange rates can seem impossible, especially for new investors. With experience though, you will start recognising the patterns and calendars for updates and announcements. Understanding these five factors and how they impact foreign currency exchange rates will give you a good foundation for trading and allow you to better identify good investments in the long run.

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