Thursday, 12 January 2012

Understanding Influences On The Market

The next step in your goal to successful investing is to understand what the influencing factors are on the foreign exchange market. Traders use fundamental analysis to try to forecast the effect that economic, social, and political events will have on currency prices. There are 3 main focus points which traders watch to predict movements.

Interest rates:
Every currency has an overnight lending rate which is determined by that countries central bank. The central bank makes the decision based on the level of inflation. If inflation is to high the central bank will raise the interest rate to slow down spending and relax the economy. If inflation is to low the bank will lower the interest rate to encourage spending and essentially economic growth. Lowering the interest rate typically suggests that the value of the currency will decrease. This is partly due to to carry-trades which is a strategy many traders use where they will sell a currency with a low interest rate and buy a currency with a high interest rate.

One of the best indicators for economic strength is the rate of unemployment. A high rate of unemployment suggests that the economy is not strong enough to provide people with jobs. This often leads to its currency losing value.

Geopolitical Events:
All markets are effected by key international political events. These can results in movements either way.

You need to remember though, that three events can occur at the same time, for instance, employment rates may be dropping exponentially which causes the central bank to lower interest rates in an attempt to encourage the economy while political leaders may meet to discuss the problems.

It is also important to remember that sometimes markets don't behave how we predict they will, a country may raise its interest rate and have nothing happen to its currency value.