What Makes the Forex Market Move?
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Despite its size, the forex market appears relatively fluid at first glance. When you look at the most popular currency pairs, there are no crazy gaps like you can often see with stocks.
Thanks to its liquidity and accessibility, forex can appear much more tame than it is. However, appearances are deceiving. Around the world, around the clock, armies of analysts, associates and other numbers analysts are compiling the data for crucial reports.
This is the news that pushes the market, leaving a trail of traders in both wealth and poverty.
It is also the most liquid of all financial markets. Due to its decentralized structure, it operates without a prescription (OTC) 24 hours a day, 5 days a week.
Since currency quotes are proportions of one currency to the other, each transaction involves the simultaneous purchase of one and the sale of another currency. This price is also known as the rate and shows the value of one base currency compared to the value of another (over-the-counter) currency.
For example, the euro against the US dollar is traded as EUR / USD, while the US dollar is traded against the Japanese yen as USD / JPY. Some currency pairs have nicknames, the most common being Cable for GBP / USD and Loonie for USD / CAD.
Along with the major pairs (the most liquid), there are minor pairs, in which the major currencies trade against each other (for example, EUR / GBP, GBP / JPY).
What makes the market move?
Consider these reasons.
Central bank meetings (rate decisions)
By far the most important news about the currency markets. As central banks conduct monetary policy, they do so by setting the base interest rate. This rate dictates the interest for lending money between institutions, consequently controlling the flow of money from the economy.
The boards of directors of central banks generally meet several times a year to vote on rate policy. The options are to raise, lower or keep the rates posted. Recent trends drove the rate to the lowest point in the US after the Federal Reserve Bank lowered the rate to 0 while stimulating the economy by making financing cheaper.
Unemployment data is crucial as it measures the general state of the economy. While all countries regularly release this data, the biggest employment news comes on the first Friday of the month, when the US Bureau of Labor Statistics reports the Non-Farm Payroll report. Shows the change in employment without taking into account seasonal agricultural employment.
US dollar crosses generally experience sharp swings during this event as the world market is taking in the news. It is not uncommon to see the price move more than 1% in either direction.
Each quarter, investors search for gross domestic product (GDP) reports that assess the overall health of the economy. These reports show the annualized change in the inflation-adjusted value for all goods and services created in the economy.
Since the forex market is traded in pairs, it is enough for a country to lose its GDP estimates to trigger a backlash as investors rally to sell it in favor of buying the most promising one.
A hot topic of late, inflation is measured by the change in the price of a standardized basket of goods and services. This is another of the control tools for monetary policy, since central banks monitor inflation in search of guidance to change interest rates. While the data is released monthly, it is often compiled into quarterly and annual reports, often cited as a year-over-year change.
Unfortunately, the CPI is not the perfect measure as it suffers from 2 biases. First, there is a substitution bias as consumers tend to change their purchases, depending on the elasticity of demand. The second is a quality / new good bias, as the basket tracks the price but does not take into account the quality improvements of certain products. This is evident with some of the rapidly developing technology products, such as mobile phones.
They are often used as a leading indicator because they are published monthly. Therefore, its effect remains to be seen in macroeconomic reports such as the quarterly GDP reports.
When consumers feel safe, they will spend more, leading to increased economic activity. However, if productivity and wages do not increase while retail sales increase, this may be an indicator that people are sourcing for a slowdown. Therefore, retail sales should not be the only source of sentiment.
Research is key
Quality research takes time and dedication
Here are some guidelines for conducting an actionable forex investigation:
Keep a weekly news schedule – Look for high and medium impact news and plan your trading schedule around that.
Check out the financial media – Financial media often run special reports and coverage ahead of key market news. Sometimes this includes early estimates and analyst reviews. Take advantage of that material.
Compare the effects of seasonality – Currency pairs have seasonal trends that have been studied for decades. Keep this in mind, as the seasonal effect often acts like gravity.
Keep an eye on the news
Although the market moves most of the time normally, various types of news reports demand your attention.
If you are a day trader, your morning routine includes checking the news program to avoid unnecessary risks. If you are a long-term trader, you should keep an eye on fundamental news to manage your existing positions and preferably avoid entering new positions just before news events.
This does not mean that trading the news cannot be profitable. But, for those who are not seasoned professionals, it often feels like picking up pennies in front of a bulldozer.