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4 Factors That Make Currency Markets Tick

Once you are ready to step into the currency trading arena, it’s important that you understand the factors that impact currency markets.

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Currency trading is the world’s most lucrative market, with trading volumes more than $5 trillion per day. The countries most involved in currency trading include the United Kingdom (37%), the United States (18%), Japan (6%), Switzerland (5%), Singapore (5%), Hong Kong (5%), Australia (4%), France (3%) and Denmark (2%).

This data was provided courtesy of the Bank for International Settlements at its 2010 Triennial Central Bank Survey. The numbers change slightly from one year to the next, but the bulk of currency trading activity (50% +) takes place in the United Kingdom and the United States.

As a trader, it’s important to understand why one currency moves relative to another in the markets.

1. Speculators

If you’ve watched Wall Street: Money Never Sleeps, or read any of those fabulous novels on Wall Street brokers hedging their bets on this financial asset or that financial asset, you know how powerful an effect speculators have on the markets. Speculators are known to inject vast quantities of liquidity into the financial markets, driving markets in one direction or another.

It has often been said that nobody has the power to alter the direction of market movement, but when mass sentiment, fueled by speculators drives markets, it is a powerful factor. For example, if Wall Street ignites with a dollar selling frenzy, the USD will be dumped en mass and it will depreciate accordingly. It’s always important to follow the actions of major market players when trading currency pairs.

2. Interest rates

Everyone watches interest rates – not only currency traders. If you have a credit card, you’ve got a pretty good reason to be concerned about rising interest rates. Currently, the Fed is on a monetary tightening path. This means that it is raising interest rates and reducing the monetary supply in the US economy. How does it do this? By selling its vast balance sheet of $4.5 trillion worth of assets, global and domestic participants will pay USD to the central bank which it can then take out of circulation.

Less money supply raises the value of the USD. The same is true of interest rates. When the central bank (the Fed) raises rates, banks pay more to store your money, but you also pay more in interest-related charges. More money gets taken out of circulation with higher interest rates. If we look at the cable (GBP/USD) a rate hike by the Bank of England would make the GBP relatively more desirable than the USD. Traders would likely purchase sterling and sell dollars.

3. Geopolitical Uncertainty

Renowned Forex trading specialist Stanley N Phillips always advises traders to be aware of geopolitical events and their impact on currency trading. Geopolitical events are things like the Brexit referendum, the UK election, the French election, tensions with North Korea, OPEC oil meetings, etc.

These events have the capacity to completely upend markets and drive traders towards safe haven currencies and assets like the JPY and gold bullion. When traders are fearful, they typically dump emerging market currencies such as the ZAR, and purchase the EUR, GBP, or even USD. Geopolitical tensions can significantly affect the way markets react to stocks, bonds, indices and currency pairs.

4. Inflation

Inflation considerations should always be factored in vis-à-vis currency trading. What is inflation? It is an economic situation where prices are continually rising. You may believe that we are in a constant state of inflation, since prices hardly ever seem to go down. However, countries with lower inflation rates tend to have appreciating currency values.

This means that that currency can buy more per unit than other currencies associated with higher rates of inflation. Higher inflation is associated with higher interest rates to combat the high inflation. If the inflation measure indicates rising inflation, this is typically associated with bearish sentiment for that currency.

There you have it! 4 factors that will affect your currency trading activity on the markets. Fortunately, when one currency is rising, the other is falling so there is always money to be made in FX.

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