The currency market is a way of taking an in-depth look to analyze how a country performs, or to put it better, an overall view of the economic health of a nation. The currency market is vast and the price of one currency relative to another is ever-changing due to the unpredictable nature of the world, current events, supply, and demand.
There are currently 180 recognized currencies in circulation worldwide, in use in 195 different nations. Such recognized currencies of the United Nations are known as Fiat Currencies with the oldest being the Great British Pound which dates back to the 8th century and is still in use today-recognized as one of the power 3 alongside the Euro and US Dollar in the Forex Market. It is normal for traders to be given the option to choose one of the 3 aforementioned currencies like the' baseline' currency within their account when they open an account with a Forex broker.
This article will discuss how different economic and global factors can influence currency markets and, in effect, how this can impact your decision as a trader, when to enter the market and when to stay away from a competitive marketplace. What's more, how to decide when a currency pair should go long or short.
Tradable currencies
Existing 3 core categories of tradable currency groups when trading Forex.
Big Pairs-The eight common pairs all comprising USD as the base currency or counter currency and one of the following-EUR, CAD, GBP, CHF, JPY, AUD, NZD.
Cross Pairs-These are any 2 major currencies that do not include the US dollar as the base currency or counter currency. These are known as being more unpredictable than Major Pairs. Sources include GBP / AUD, EUR / CAD and to name only a few, NZD / CAD.
Exotics-These are literally exotic currencies, lesser-known currencies that can be extremely volatile on the market. These include South African Rand, Polish Zloty and Hungarian Forint.
Inflation rates
Inflation rates have an effect on every customer, trader or company in some way, shape or form-this is one of the key drivers that can affect goods and commodity prices, stocks and, crucially, the Forex market.
Inflation can be used as a metric to calculate how much goods and services ' inflate' over time (increase). Inflation increases mean that prices of said goods and services are rising rapidly. That being said, although the rate of inflation is dropping, commodity prices are still on the rise-only at a slower pace.
When inflation rates increase, a household's spending power may decrease, meaning households may have to cut back on a couple of luxuries and economize in some places. I, e.g. Buy cheaper butcher's meat cuts or don't buy designer footwear. This can have a wider impact on countries as a whole and the overall performance of their currency on the Forex market, on a larger scale. Deflation will say the same. When investors see that the prices of goods and services are dropping, this may suggest that the economy is not in such a good shape-meaning that inflation, as well as deflation, can be indicators of a poorly performing economy, which in effect negatively impacts the currency of a country.
In situations as stated, this is where central banks usually step in and try to find a suitable level of inflation usually close to the mark of 2 percent. If the inflation rate falls within the range set by a central bank, a currency value won't get too much affected. And, if this goes outside the inflation range, then the currency value of a particular nation may be drastically affected. Central banks are moving towards raising interest rates to combat this and protect consumers.
In terms of Forex trading, a trader usually buys a currency within their fx account (going long) when inflation rates are high. If a trader sees central banks raising interest then this is a key indicator that will lift a currency's value. That being said, too much inflation within an economy will harm the capital. For these reasons, it is useful to understand inflation rates as an economic indicator but it is very difficult to use them as a sole indicator of whether a currency's value will rise or fall.
There are several; inflationary causes. These include government debt, monetary and fiscal policy, consumer confidence, cost of production and devaluation of the currency to name but a few.
Government debt
They take on debt when a government borrows money. Governments must implement policies to offset the aforementioned debt and recover those monies. Strategies can include a rise in printed cash money or, likely, the most common type-tax hikes. In addition, higher taxes on companies would affect the customer in that they pay a higher price for the made goods and services.
This is a natural chain effect in the cost of commuting, the further down the chain of money goes-passing on the corporate tax rise to the customer to continue to operate on a profit. Increasing a country's money supply is the primary inflationary source.
Government debt can be used as a Forex trader as a strong indicator of economic stability. When we use Greece as a case study and the 2009 bank crash, this has led to an increase in interest rates and a mistrust in the banks as such. As an investor, one would look at the impact and pressure this would have on the euro, as the EU was trying to bail out financial ruin on Greece. In this situation shortening the Euro would be easier.
Ironically, this affected Cryptocurrency as well. The Greek bank account holders who held more than $100,000 in their accounts were liable to contribute to paying off the EU debt when the bailouts took place in Greece. This was a term and condition set by Brussels because they would not bail out the full amount of Greek banks. With over $100,000, account holders had wiped out up to 40 percent of their capital. This naturally had a huge impact on the value of the Euro. What it also signaled was a transition to Cryptocurrencies from centralized currencies in the trust.
Due to massive mistrust of centralized banking structures, the price in Cryptocurrency soared at the time of the crash. Traders capitalized on this government debt and went long with profit in mind on Cryptocurrencies.
Interest rate
Interest rates are set by central banks as a means to manage an economy by 2 standard methods; Raise interest to control inflation Reducing interest to assist economic growth As central banks of countries to lend money to other banks, standard interest dictates how much money the borrowing banks will repay. Larger banks also lend in the form of loans to smaller banks as well as to civilians and businesses for interest gain.
As banks increase their interest rates, lenders are inevitably subjected to higher expenses as borrowing-interest rates rise as does the amount of money that comes back to the bank.
Higher interest rates indicate that borrowers will have a rise in their monthly mortgage repayments, to bring interest rates into perspective. This is a method for fighting high inflation. If a household has less disposable income every month they are not going to spend excessively. Households with higher outgoings should spend less on non-essentials. When competition for products decreases, so does the price of goods and services.
Higher interest rates come with a few advantages. A higher interest rate indicates a stronger economy which means potential investors are increasing. This means the more investment in an economy, the stronger that country's currency is.
As a trader, look for a forex broker that will enable you to trade on a range of currency pairs. The more interest rate research a trader puts into, the better they'll have of economic performance. A strong economy shows a strong currency.
Summary
What we can take away from this article is that economic indicators unquestionably help identify an economy's strengths and weaknesses. As a trader and aiming to become a successful Forex trader, we may use such economic reports to determine a nation's currency's likely value.
Increased interest rates are used as a tool to keep inflation down and to help stimulate economic growth. When we look at inflation we can see that this is a tool used to measure price increases on products and services and how they increase over time.
As a trader, it is important to use a range of research materials when thinking about the strength of one currency lined up against another. What is also of pinnacle importance on the path to success is to remain current. What we mean by this is keeping up with the latest market news, economic events and global political events to keep a handle on where markets might move.