The foreign exchange market is much like any other financial market - it circulates around swapping one thing for something worth more. In the Forex market you are swapping the currency of one country for the currency of another. The values of these currencies change routinely in very short time frames, but why? When you learn Forex trading through some format of Forex trading training you may be educated about this issue but in this article we will go through the basics that influence the changing of values.
Much like in general economics, a currency will generally become more valuable at a time when demand is greater than supply and less valuable when demand is less than supply. People around the world are not suddenly deciding that they no longer want money - perhaps they just prefer to hold their wealth in another investment type, or even a different currency. This could be why some poorer countries inhabitants trade in US dollars.
The value; or demand for a currency is dependent on a multitude of factors from within the economy of that country. It would be impossible for one single person to know exactly what a country's currency is worth as there are just too many factors, hence the continued changing of a currency price whilst people are trying to decide what they think its value is. Some factors that influence the value of a currency are:
- Gross domestic product
- Employment levels
- Business activity
- Central bank interventions
- Inflation
- Interest rates
Once you begin your Forex trading training you will notice that people also pay attention to the predicted worth of a currency in the future, thus the predicted strength of a countries economy in the future. If people think a currency will devalue in the future then there is little reason to own it. Political uncertainty, war and natural disasters within a country can all lead to longer and sometimes rapid changes in its currency value. Whilst you learn Forex trading and you trade on your demo account you will see just how quickly the values can actually change.
The Forex market is not an equal market. Each currency is valued different to another. This can also be described in terms of purchasing power; in a neutral market you would be able to buy the same product in one country as you could in another because the value of the currencies between the two countries would be equal. Obviously that is not what happens. This is why some countries can seem "cheaper" to others, whilst others can seem more "expensive".
Some currencies can be "pegged" to another currency, meaning that the currency value can still change but only in relation to another. This is normally favoured by developing countries that are concerned in promoting stability.
The main point to note in relation to currencies changing value is that nobody can predict what changes are going to happen. There are far too many variables and unknowns. We can therefore conclude that in the world of Forex trading all players are equal.