Because the Forex market is not a perfect place to try your luck, in “MASDAR INV” we always recommend for our clients that they acquire a basic understanding of the Forex market and the factors affecting the prices of various currency pairs before they start trading.
In general, the price movements in the Forex market are either due to fundamental factors or technical factors, in this article we go through the basics of the fundamental factors to help you in understanding the market properly.
- Political conditions.
- Actual cash flows, such as cash flows which related to imports and exports, mergers and acquisitions, as well as expectations about cash flows.
- Banking regulations which severely affect the prices of currency pairs in the Forex market.
- Important news which is released to the public on a regular basis at specific dates and times, which include:
1.Monetary policies as posed by central banks.
2.Economic conditions which are generally indicated through economic reports such as GDP growth, inflation, unemployment rate, relative interest rates, deficit or surplus in the budget and trade, consumer confidence, and so on.
Internal and global political conditions and events heavily affect the currency market, as currency exchange rates are strongly affected by political instability, for example prior to the elections, with the expectations towards the new ruling party, as political changes and political instability can have negative effect on the economy of a nation, as can the events in a country or region cause a negative or positive reaction in other nearby countries, and therefore those events can influence currencies pairs.
Major mergers and acquisitions among companies can create a temporary increase in the demand for a particular currency, which drives the currency to rise, trade flows between countries paints a picture of the demand for goods and services, which also reflects the level of demand for the currencies of different countries, as the surplus or deficit reflects the commercial competitiveness of the state’s economy, large trade deficits, for example, means that imports are greater than exports, leading to a negative impact on the country’s currency.
- Fiscal policy: it is the way the government chooses for the management of revenues from taxes and so on, compared with expenditures of spending on health, education and defense. The difference between both is called either governmental surplus or deficit, and the currency of each country usually has negative sensitivity to the increase of the governmental budget deficit, and a positive sensitivity to the increase of surplus.
- Monetary policy: it is the way in which the central bank influences the amount of money supply, as well as the cost of money. The cost of money is reflected by the interest rate of the currency, while the money supply is managed by the ability of the central bank to sell or buy government bonds. High real interest rates (which are official interest rates minus inflation) represent an attraction factor for capital investment, resulting in the rise of the currency. The level of interest rates also affects the local economy as the higher interest rates slow down economic growth. In times of slowing economic growth and falling inflation, central banks tend to reduce interest rates to help growth to return to the desired level. While adding more money to the market through the purchase of government bonds helps the economy to grow and increases inflation, on the other hand, the reduction of the money supply by selling government bonds slows down both economic growth and inflation.
There are a lot economic statistics, which are issued on a weekly or monthly basis and are usually followed closely by traders as they also predict the potential results, which can cause a reaction to the real results, to wither the results were better or worse than the expected level, leading to a rise or a decline in the market, and the most important of those statistics are:
- The level of inflation: currencies usually tend to decline if inflation, or if the level of inflation is tending to rise, and this is because inflation reduces the purchasing power of the currency, and thus reduces the demand for it, but sometimes a currency may rise as inflation gets higher due to expectations that the central bank will increase short-term interest rates to counter the higher inflation.
- Economic growth: reports such as GDP, employment levels, retail sales, the level of capacity utilization and others detail the level of economic growth and the extent of its strength in every country, and in general whenever the country’s economy stronger, the better it is for the currency of that country, and while economic reports reflect economic policy, some economic reports may have a low or doubtful impact, as some reports may become important to decide the market psychology, and have an immediate impact on the market movements in the short term, on the other hand, the reports which have sustainable effects on the market can change with time, In recent years, for example, unemployment reports, trade balance and inflation became the most important reports in the market.