Discover the Influence of Economic Factors on Forex Trading

Also, Gauge Knowledge of Relationship between Equity Market and Economics Here

Forex market or foreign exchange market is the largest market in the world, with a daily turnover of about $5 trillion. Moreover, the forex trading market represents one of the world’s most actively traded markets, which involves the participation of several currencies and numerous individuals.

Considered as the most liquid asset market, the forex market is highly decentralized with many large players, including central banks, commercial companies, investment banks and hedge funds participating in the trading.

But what does the forex market deal into?

The forex market involves transfer/exchange of currencies within a broad network of buyers and sellers at an agreed price, which is also referred to as forex trading. A vast majority of currency conversion is conducted each day in the global market, with an objective of earning profit.

Most of the trade in the forex market is undertaken among currencies of the eight countries - United States, Japan, Eurozone, Switzerland, United Kingdom, Canada, New Zealand and Australia.

Forex Trading - A Lucrative Form of Investment!

Forex trading is rapidly becoming a popular form of investment among modern investors, who consider it as a reliable platform to make money. Let us scroll through some of the features of forex trading that makes it an attractive form of investment:

Flexibility: The forex trading provides time flexibility to participants as it involves global electronic currency exchange and operates for 24 hours each day. The time flexibility allows participants to enter or leave the market when desired.

Liquidity: The forex market is a highly liquid market as a large number of buyers and sellers seek to make a trade at a given point of time. This enables quick and easy completion of transactions, with a very low transaction cost.

Low Risk: The risk associated with the forex market is comparatively low as investors can invest even a small amount of money to begin trading. This prevents huge losses for beginner investors who first wish to check the market.

Decentralised: As the forex market is decentralised, no single institutional trader can control exchange rate prices for an extended period of time. With no middlemen in between, the market is influenced by the economy itself, not one company or a person.

Factors Influencing Forex Trading

Though the forex trading comes with multiple benefits, before indulging in forex trading one should be aware of the factors that drive the market.

The below figure lists the economic factors influencing trading in the forex market and their respective figures in the Australian economy:

Interest Rates

The movement of exchange rates between the countries is majorly affected by the interest rates decided by the global central banks.

Higher/elevated interest rates usually boost the value of a nation's currency in comparison to countries with lower interest rates. Foreign investors generally prefer investing in a country with higher interest rates to yield better returns.

For Instance, the Australian dollar has depreciated in value since the RBA’s first rate cut move in June 2019. It is imperative to note that the RBA reduced the interest rates from 1.5 per cent in May 2019 to 0.75 per cent. AUD/USD depreciated from ~0.72 USD in January 2019 to ~0.69 USD at present.

Inflation

High inflation indicates that the cost of consumer goods is high in an economy, which repels foreign customers to invest, resulting in a fall in the demand and value of the country’s currency.

For Instance, the Aussie Dollar strengthened after the country reported a better-than-expected inflation figures for 2019 second quarter in July 2019. The RBA’s core inflation rose by 1.6 per cent year-on-year in the quarter, surpassing the estimated figure of 1.5 per cent.

However, it is worth pointing out that a very low level of inflation does not guarantee a beneficial exchange rate for a country.

Unemployment Rate

The unemployment rate - an important indicator of economic status affects the movements in foreign exchange rates and currency’s stability. Policymakers use the unemployment rate statistic to study which sectors lose jobs more rapidly. Moreover, the jobless rate provides forex traders with the clues about the expected monetary policies in the future and the economic stability.

Rising unemployment rates are usually negative for the domestic currency and often spark bearish turns, while falling unemployment rates lead to inverse results.

For Instance, the Australian dollar edged higher on 19th December 2019 as a result of an unexpected decline in the country’s unemployment rate.

Economic Growth

Economic growth is an indicator, which is widely used to assess the overall health of a nation’s economy. The economic growth holds a substantial potential to move the forex market as it is a best measure to validate the country’s position in the business cycle.

It is to be noted that as it takes a long time to publish GDP data, its effectiveness as a trading tool for short-term and medium-term trading is restricted.

Current Account Balance

The balance of trade influences the supply and demand for foreign exchange, influencing currency exchange rates.

If exports exceed imports, it reflects a high demand for a country’s goods, which results in high demand for its currency. In other words, a high demand for goods result in high prices, leading to appreciation in the value of currency.

Government Debt

A lesser known fact is the government debt has a definite effect on the forex market. A country with high government debt is usually less attractive to foreign investors. In other words, a high debt without a credible plan to tackle it results in depreciation of the currency’s value.

We have seen that economic factors have a considerable impact on forex trading; however, it is worth mentioning that exchange rates also significantly influence the economy via influencing trade and financial flows between the forex partners. Hence, an appropriate knowledge of the relationship between the exchange rates and the economy is essential before indulging in forex trading.

Disclaimer

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