The foreign exchange market is one of the world’s largest financial markets; trading takes place through an intricate network of dealers, most commonly banks. Select the best forex robot.
The 2022 Triennial reports an increase in internalization – that is, matching customer flows on dealer books – and non-market-facing trades between different organizational units of dealers (Graph 6 panel C). These factors are two that may explain a decrease in inter-dealer trading activity.
Economic Factors
The foreign exchange market is an immense global ecosystem that reflects all facets of the world economy. Its movements are determined by various forces ranging from economic factors, political conditions, market psychology, and financial market dynamics – its complexity must be fully comprehended for proper understanding.
As inflation rises in a country, its currency’s purchasing power declines, and demand drops on foreign exchange markets. Figure 12.2 shows this phenomenon through its reduction of the distance between Qd and Qw; an accompanying rise in supply can be seen through an increase in S.
Foreign exchange markets are heavily impacted by currency attractiveness. Countries with higher accurate rates of return typically attract more foreign investment, and their currencies appreciate accordingly; conversely, countries with lower accurate rates of return discourage investments, leading to their currencies declining in value. The USD remains the dominant force in the FX market, with over 90% share for spot, forward, and swap turnover (Graph A1). Its dominance has held steady over time despite emerging market economies’ currencies like the Renminbi becoming increasingly prominent; both yen and euro also enjoy significant market shares, which remain constant over time as well.
Interest Rates
Interest rates play a pivotal role in shaping the supply and demand of currency since rates of return vary across nations. When interest rates are low, people will move capital to countries with favorable savings/investment returns in search of higher returns, thus driving up demand for the local currency; when rates are high, however, residents of a given nation will often choose to invest abroad instead, reducing demand locally.
This shift will decrease the price of the local currency while simultaneously altering its exchange value as interest rates adjust to account for movements of funds in and out of the country.
2022 Triennial Survey results reveal daily turnover in OTC FX markets reached $7.5 trillion per day, a 14% increase compared to 2019 ($6.6 trillion). This growth can be attributed to rising volatility and evolving interest rate expectations; spot and forward turnover decreased while swaps’ market share rose steadily from around 40% in 2013 to over 50% by 2022; compression trades, which are not officially recorded surveys, have also experienced steady increases over time.
Political Factors
The foreign exchange market is an intricate system with numerous factors that influence it, all of which vary significantly. The main ones can be broken down into three broad categories: economic factors, political factors, and market psychology. Economic influences include inflation rates and interest rates that can have dramatic effects on currency strength in Forex trading; political events or significant policy shifts also have lasting ramifications on a country’s currency – for instance, the Brexit vote caused a decrease in British Pound value while Japan Earthquake caused increased demand for its yen counterpart.
Longer-term economic strength and its global status play integral roles in shaping its currency value. Furthermore, international trade and investment flows are essential in driving currency movements.
Beliefs about the future path of exchange rates also influence trading volumes. If a major dealer believes that Mexican peso prices will appreciate against the dollar, for instance, they may increase demand for dollars while simultaneously decreasing the supply of Mexican pesos—this can create a self-fulfilling prophecy, at least temporarily; indeed, dealers’ expectations regarding exchange rate futures account for much of their FX trades.
Currency Pairs
Currency pairs’ value is determined by their respective economies’ strength or weakness, so a trader who goes long on EUR/USD, for instance, is betting that its value will increase against the dollar; conversely, when betting short against USD/JPY, they hope it decreases against the yen; to maximize profits, traders must correctly predict in which direction this pair of currency moves.
Foreign exchange markets feature many currency pairs, but only certain ones dominate trading volumes. These significant pairs include EUR/USD, USD/JPY, GBP/USD, and USD/CHF, as these all involve currencies with developed economies that support high trading volumes.
These currency pairs are traded using two prices, known as bid price and ask price, respectively. Bid price indicates traders’ willingness to purchase an asset, while ask price signifies their desire to sell one; the difference in these values constitutes the spread, which makes up most of a pair’s total market capitalization. Following these four significant pairs are several non-US dollar pairs known as commodity pairs that also trade extensively on global financial markets.
