What is foreign exchange (forex): Foreign exchange, commonly known as forex, is the global marketplace for exchanging one currency for another.

It is the largest and most liquid financial market in the world, where currencies are bought and sold in pairs. The forex market operates 24 hours a day, five days a week, encompassing major financial centers across different time zones.

At its core, forex trading is about the relative value between two currencies. When you exchange one currency for another, you are engaging in a forex transaction. These transactions can be for various purposes, including facilitating international trade, tourism, or speculation on currency movements.

source: tradingview

Unlike stock markets, forex has no centralized exchange; instead, it is a decentralized network of banks, financial institutions, corporations, governments, and individual traders. Due to its high liquidity and continuous operation, the forex market plays a vital role in the global economy by enabling currency conversion and price discovery.

What Moves the Forex Markets? Explained with Examples
The value of a currency in the forex market fluctuates constantly due to multiple factors that influence supply and demand. Understanding these drivers helps clarify why currencies strengthen or weaken relative to each other.

1. Economic Indicators and Reports

Economic data releases from countries can affect the perception of currency strength. For instance, reports related to employment, manufacturing output, retail sales, and inflation provide insight into economic health. When an economy shows robust growth or controlled inflation, its currency may attract more demand.

Example:
If a country releases a report showing growth in its manufacturing sector, traders may interpret this as a sign of economic strength, increasing demand for that country’s currency relative to others.

2. Central Bank Policies

Central banks play a crucial role in shaping currency values through their monetary policies. Decisions on interest rates, quantitative easing, or tightening liquidity impact the attractiveness of a currency. Higher interest rates can draw capital inflows, increasing demand for that currency, while lower rates may reduce its appeal.

Example:
When a central bank signals a future increase in interest rates to control inflation, the currency often strengthens in anticipation of higher returns on assets denominated in that currency.

3. Political Events and Stability

Political developments such as elections, policy changes, geopolitical tensions, or trade agreements influence currency movements. Stability and predictability in government policies tend to support a currency’s value, while uncertainty or conflict can lead to declines.

Example:
A country entering trade negotiations that promise to improve export conditions may see a boost in its currency as traders expect increased economic activity.

4. Market Sentiment and Speculation

The collective mood of market participants can drive fluctuations in currency values. Sentiment is shaped by news, rumors, and expectations about future events. Even without concrete changes in fundamentals, perception alone can move the market.

Example:
If market participants anticipate that a currency will weaken due to upcoming political unrest, they may sell that currency, pushing its value down before any event occurs.

5. Trade Balances and Current Account

A country’s trade balance—the difference between exports and imports—affects currency demand. A trade surplus means foreign buyers are purchasing more goods and services, often requiring the domestic currency, which can increase its value. Conversely, a trade deficit may weaken the currency.

Example:
If a country exports more than it imports, demand for its currency may rise as foreign buyers convert their money to pay for goods.

6. Global Economic Events

Events that impact the global economy, such as commodity price changes, economic crises, or pandemics, influence forex markets. Currencies of countries heavily reliant on commodities or global trade can be especially sensitive to such developments.

Example:
A sharp decline in oil prices may weaken the currencies of oil-exporting countries, reflecting expected lower revenues.

7. Relative Strength Among Currencies

Forex trading is always between two currencies, so the strength of one currency is relative to the other. Even if a currency remains stable in isolation, if the paired currency strengthens, the relative value will shift.

Example:
If one country’s economy slows down while another’s grows steadily, the currency of the stronger economy may gain value relative to the other.

Summary

Foreign exchange markets reflect the dynamic relationship between currencies driven by economic, political, and market forces. These factors continuously interact, influencing supply and demand and causing currency values to fluctuate. Understanding the main drivers such as economic data, central bank actions, political environments, and global events can help make sense of how and why currencies move in the forex market.

By observing these influences and their interactions, traders and participants in the forex market can better navigate the complexities of currency trading. The forex market’s vast scale and continuous operation make it a critical component of the global financial ecosystem, facilitating trade and financial flows worldwide.