What Drives the FOREX Market?
Forex is a global, decentralized market that facilitates the exchange of one country's currency for another. Currencies that trade in the Forex market are priced in relation to other currencies. For example, the price of the dollar is meaningless unless it is compared to a currency such as the Euro. The Forex market is very large, and currency prices are impacted by a wide range of factors.
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Politics
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The politics of a country can have a big impact on its currency price. For example, elections that usher in a conservative party likely to impose austerity measures may raise the value of that country's currency as investors determine the new government will reduce the rate of inflation. In addition, markets don't like uncertainty, and political unrest in a country is likely to cause investors to sell, reducing the price of the currency.
Central Banks
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Central banks for most countries set official interest rates. In the U.S., for instance, the Federal Reserve (Fed) determines at what rate the government will make short-term loans to banks. This is how the government increases or decreases money supply in the system. If it wishes to increase the amount of available dollars, the Fed reduces rates. More money in the system can help spur economic growth, but it also creates inflation. Thus, interest rate reductions tend to cause currency prices to fall in the Forex market.
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Speculators
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Prices don't always move because of government policy and other fundamental factors. Prices also move based on what speculators think will happen. If traders believe future prices should move higher, they buy. This in turn has a self-fulfilling effect as buying causes prices to rise. Emotions swing the markets as well. People sometimes buy and sell based purely on fear and greed, impacting prices in various ways.
Business Transactions
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Forex is the largest market in the world. Literally trillions of dollars exchange hands every day. Large banks and corporate interests make up the vast majority of Forex trading volume as they buy and sell currencies for business purposes. Businesses working in the global marketplace sell products around the world, and as a result, they oftentimes exchange the money they earn in one currency for their home bank currency.
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References
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