What moves the forex market?

Forex pairs are constantly fluctuating in price, due to a wide range of factors. It's a key reason why foreign exchange is so popular among traders. To understand the forex market, you'll need to know precisely what might kickstart a new trend in your chosen markets. Here's a breakdown of the biggest drivers of forex volatility.

As discussed in the fundamental analysis course, central banks wield significant influence over multiple financial markets, with one of their most direct impacts being on currencies.

Even if you focus primarily on technical analysis, it’s essential to stay informed about the actions of the central banks behind the currencies you’re trading. Here’s a breakdown of what to keep an eye on if you’re trading USD, EUR, or JPY.

USD (US Dollar)

The US dollar is by far the most-traded currency, featured in every major currency pair and serving as the world’s reserve currency, forming the backbone of global financial markets.

This means that the Federal Reserve’s actions, especially those of the Federal Open Market Committee (FOMC), which meets eight times a year to set the US base interest rate, heavily influence all major FX pairs.

Traders closely monitor clues about the future direction of US interest rates. Any hint of a potential rate hike can lead to an increase in USD value, while signals of a rate cut can cause the USD to decline.

Key indicators to watch include CPI data from the US Bureau of Labor Statistics and non-farm payrolls. Why? Because the Fed prioritizes high employment as a sign of a growing economy. If employment is low, the Fed may lower rates; if employment is high, rate hikes could be on the horizon.

Remember, the effect of a rising or falling USD will vary depending on whether the dollar is the base or quote currency in a given pair.

EUR (Euro)

The euro is the second-most traded currency globally, largely due to its role in the EUR/USD pair, which dominates global forex trading. The euro is also central in important minor pairs like EUR/GBP and EUR/CHF.

While the US has the Federal Reserve, the eurozone is governed by the European Central Bank (ECB). The Governing Council meetings, held every six weeks, are crucial to follow. These meetings determine the interest rates that national central banks (NCBs) can offer to commercial banks.

JPY (Japanese Yen)

Central banks influence currencies not only by adjusting interest rates but also by intervening when a currency's value starts to negatively impact the economy.

In Japan’s case, the economy heavily relies on exports. Countries that depend on exports generally prefer to keep their currency from appreciating too much. The table below explains why a stronger currency can be detrimental for export-driven economies like Japan's.

If JPY is too strong against USD, then Japanese exporters make much less money. They might have to increase their prices, which could see overall sales fall. In this instance, the Bank of Japan might flood the market with JPY by releasing reserving cash. This supply glut should cause the yen to depreciate, meaning USD/JPY rises.

Other factors to cross reference

1. Government announcements
Governments are responsible for fiscal policy, which also has a major impact on currencies.

To fund a new infrastructure project, for example, the government will have to borrow money in the form of bonds to sell to investors.

2. Market sentiment
In their simplest forms, fear can turn a falling instrument into an all-out panic and greed can turn a rising market into a blind-buying spree.

While it may be easy to point out the effects of fear and greed on markets after they have acted upon them, choosing the moment when they flip in the present is difficult.

3. News
The Economic Calendar is a great resource to help you determine which reports provide the most punch. While not all important news events move the needle when their number is called, they have the highest probability of doing so, and knowing when the markets will move can be one of the greatest advantages you have as a trader.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.