Currency trading is popular among traders because of the constant fluctuation of Forex pairs in price. To become a successful Forex trader, it is important to understand what might trigger a new trend in a chosen market. Several factors drive Forex volatility, and in this article, we will break down the biggest drivers of Forex volatility. We will begin with the biggest driver of them all: central banks.
Central banks have a significant say over multiple financial markets, but they have the most direct impact on currencies. Even if one plans on a purely technical approach, it is essential to be aware of the central banks behind chosen currencies’ plans.
The US dollar is the most-traded currency and is used as the world’s reserve currency, making it the backbone of financial markets. This means that every popular Forex pair is hugely influenced by the actions of the Federal Reserve. The Federal Open Market Committee (FOMC) meets eight times a year to set the base rate for the US. The markets will look for any clue on the future direction of interest rates. Any indication that they’ll fall can cause USD to fall, and any sign that they may rise can see USD rise in value. The USD going up or down will have a different impact on different pairs, depending on whether the dollar is the base or quote currency.
The second-most popular currency on the markets is the euro, which forms one half of EUR/USD, making up an overwhelming majority of global Forex trading. The European Union has the European Central Bank, and the Governing Council meetings are the key ones to watch. They take place every six weeks and are used to decide the rates national central banks (NCBs) can use with commercial banks.
Central banks do not only affect currencies by setting interest rates. Sometimes, the value of a currency can inflict harm on an economy, leading to its central bank stepping in. Japan’s economy is dependent on exports. If JPY is too strong against USD, then Japanese exporters make much less money. In this instance, the Bank of Japan might flood the market with JPY by releasing reserved cash. This supply glut should cause the yen to depreciate, meaning USD/JPY rises.
Other factors that impact currency prices include government announcements, market sentiment, and news. Governments are responsible for fiscal policy, which has a significant impact on currencies. For instance, to fund a new infrastructure project, the government will have to borrow money in the form of bonds to sell to investors. Fiscal stimulus measures are agreed upon by governments, and sometimes a vote needs to take place to make the stimulus law. It pays to keep up to date with breaking news events to ensure one does not miss these crucial decisions.
Market sentiment can turn a falling instrument into an all-out panic, and greed can turn a rising market into a blind-buying spree. News events also impact currency prices. Employment reports tend to move markets more than a manufacturing sales report, and a retail sales figure riles things up more than a monetary supply report. While not all important news events move the needle when their number is called, they have the highest probability of doing so, and knowing when the markets will move can be one of the greatest advantages a trader can have.
In conclusion, traders must pay close attention to several factors that impact currency prices to be successful in Forex trading. Central banks have a significant impact on currencies and their interest rate decisions. Other factors that influence currency prices include government announcements, market sentiment, and news events. By keeping up to date with breaking news events, traders can increase their chances of making successful trades.
