3 Main Factors That Drive FX Markets

Global FX markets can potentially provide a wide variety of trading opportunities. As the largest financial market on the planet, foreign exchange markets can be influenced by numerous inputs. Here are three of the biggest factors that drive trade in modern FX markets:

 

  1. Interest Rates and Monetary Policy: Interest rates and monetary policies play a major role in modern FX markets. At any given point, currencies may be valued based on prevailing interest rates of the issuing sovereign as well as the policies of its central bank. Higher interest rates, for example, may draw buyers into a currency as that currency may potentially provide higher yields. On the other hand, lower interest rates may potentially cause the value of a currency to decline, as investors may seek higher yields elsewhere.
  2. Risk Appetite and Aversion: Although trading any currency involves risk, some currencies are generally considered to be more or less risky than others from a macroeconomic point of view. For example, currencies such as the Australian Dollar or the New Zealand Kiwi may be considered higher risk, as their counties are heavily dependent on commodity prices. Currencies such as the U.S. Dollar and Japanese Yen, on the other hand, may be considered more stable and less prone to cyclical risks. The U.S.  has the world’s largest economy, while Japan has the third largest economy. Due to this, their respective currencies may be considered a “safe haven” during times of economic or geopolitical turmoil.
  3. Inflation: Inflation is essentially when the cost of everyday goods and services is rising. While a little inflation is healthy from and economic standpoint, too much inflation can become problematic. Nations that have stable or little inflation may see their currency values rise, as lower inflation rates may boost purchasing power. Counties that have higher inflation rates, on the other hand, may potentially see their currencies depreciate, as higher inflation leads to a drop in purchasing power.

 

Although this list is by no means inclusive of all the factors that may influence FX markets on a daily basis, it covers some of the primary issues that affect global currency markets. Other issues that can fuel changes and volatility in currency markets include current-account deficits, sovereign debt, terms of trade, government stability, recessions and speculation.

With so many potential influences on global currency markets, they can at times exhibit significant market volatility. This volatility is a double-edged sword. Although it can potentially provide significant trading opportunities, both on a short-term as well as long-term basis, it can also cause significant losses. As with trading or investing in any other financial market, potential success can only be achieved with proper risk management.

 

Even with solid risk management, FX trading carries a significant risk of loss and is not suitable for all investors.   Due to the highly speculative nature of FX markets, investors and traders should only trade with risk capital, or funds that they can afford to lose. Past performance is not necessarily indicative of future results.

 

There is a high level of risk in Margined Transaction products, such as, Foreign Exchange (FX) and Metals trading which may not be suitable for all traders as it could result in the loss of the total deposit or incur a negative balance; only use risk capital.  Prior to trading any products offered by ATC Brokers, please carefully consider your experience level and financial situation.