The forex market is – according to some estimates – 12 times larger than the global equity market. With daily trade levels totalling trillions rather than billions, the scale and scope is hugely significant. Part of the attraction of this market is its volatility – with the regular rise and fall of prices presenting an opportunity for smart traders to make money.
But, what causes these price movements? As with any asset, the short answer is that this is about supply and demand. Increased demand or a shortage of supply force the price to go up and the reverse causes a fall. But, it pays to understand some of the facts that impact on both supply and demand when it comes to the currency markets.
- Quantitative easing – While much of the focus might fall on factors that can affect demand, it’s important to realise that central banks does have a lever at its disposal when it comes to controlling supply. This involves injecting money into an economy through quantitative easing in a bid to boost supply. This has been used by several Governments in the decade or so since the financial crisis in a bid to keep inflation in check.
- Politics – The things that key leaders say and do matters. From set piece speeches to the way they react to events – as this interactive from DailyFX shows – politicians have the opportunity to establish a positive narrative for their economy and this is vital for establishing the sort of confidence required to maintain or increase demand. Politicians can, of course, also stimulate the economy through policy in the way they control tax and spending to try to boost growth and, therefore, demand.
- External reports – Politicians and central banks aren’t necessarily in total control of their own narrative, however. Reports from credit agencies and key third parties offer an outsider’s view of the health of a nations finances and can be important when it comes to influencing demand.
- Natural disasters – Mother Nature is also a potential threat to demand. Natural disasters such as earthquakes or a tsunami have the power to bring an economy to its knees, destroying the key infrastructure required to keep running on a day to day basis. In a similar way, war and terrorist activity can also harm economic infrastructure and, therefore, the value of a currency.
As you can see, the factors affecting forex are pretty varied. Some sit within the control of politicians, some with central bankers and some outside of the remit of the people in charge. The variety of factors, coupled with the fact that one or more of these could happen at once, helps you to understand why forex is a volatile market.
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