If we had a complete list of all the factors that influence the FX markets and could assign the correct weight to every factor in every given situation, it would be easy to make money with FX trades.
As things stand, however, something often happens, like the tsunami in Japan, which nobody expected and which throws forex markets into complete disarray for some time. Having said that, there are some factors which consistently affect the forex markets.
If everything else were equal, the country with the highest interest rate would enjoy an inflow of investment money as investors could expect a higher return on their capital.
Countries with high inflation rates will often try to counter them by increasing their interest rates. As stated above, local currencies of countries with high interest rates are often attractive.
As a result, higher interest rates strengthen the demand for its currency which can push up its price or exchange rate compared to other currencies. This can often happen in the market even if there is the expectation of an interest rate hike.
If America should import a lot of products from Europe, for example, it would strengthen the demand for the Euro as Americans are converting Dollars into Euros to pay for the goods. Eventually the exchange rate of the Euro against the Dollar will start to increase.
If, as mentioned in the previous paragraph, the Euro strengthens significantly against the Dollar and the American Central Bank, the Federal Reserve, doesn’t want this, the bank can interfere in the market by buying Dollars or selling Euros.
This will tend to strengthen the value of the Dollar and/or weaken the Euro and restore the balance that existed earlier.
It is not only imports and exports that drive the forex markets. There are also a huge number of speculators in the market who simply trade in the forex markets through financial spread betting, margined forex and CFDs.
Some industry analysts even claim that speculators have become the strongest force in the forex markets.
If a large investor such as George Soros should suddenly buy a vast amount of Paraguayan Guaranis, the price of this small currency could jump through the roof overnight. If he sells the same amount the following day, the price would probably drop to where it was before or perhaps even lower.
Political instability is one of the biggest enemies of any currency. If a military coup should take place in a country in the Middle East then it’s likely that the country’s currency will drop. This is because people are more willing to invest in stable countries. Conversely, a long period of political stability usually leads to a stable currency.
High unemployment figures are usually a sign that something is wrong with the economy of a particular country.
This means the GDP may also be contracting and exports falling. If so the currency in question might also drop as speculators expect the government to weaken the currency in order to help boost exports.
Financial spread betting is a leveraged product, it involves a high degree of risk to your capital and can result in losses that exceed your investment. It might not be appropriate for all types of investor. Before trading, ensure that you are fully aware of the risk. Only spread bet with money that you can afford to lose. If required seek independent financial advice.