Welcome to part two of my series.
Today we will be looking briefly at the determinants of foreign exchange markets and the economics behind them.
Currencies are all about how much
demand there is for a currency (And supply if there is an increase in the money
supply through QE).The main determinant that moves the currency markets is
interest rates.
If interest rates increase in country A it makes it more attractive
to invest money in that country A due to a higher interest rate on the money
invested, therefore global investors must buy currency in country A to benefit,
this lifts the price of currency A due to the extra demand.
Additionally if interest rates
are rising in a country, this indicates that this country is experiencing
economic growth which attracts foreign investment in domestic equities and
other investment avenues – all of which require the local currency (raising the
price).
Investors must look for economic
indicators that may indicate a rise in the interest rate such as inflation,
unemployment and GDP figures. If investors can predict potential changes in the
interest rate they can profit from the appreciation of the currency compared to
another.
Technical analysis is also
inherent in the FX market due to the inherent slow moving pace along with the
$2tn of liquidity provided every day. Technical levels such as supports,
resistances, moving averages and Fibonacci retracements are all indicators that
will move the market in the short term. Also there are many opportunities for
technical traders after significant events such as central bank meetings.
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