What Makes the Forex Market Move?

Despite its size, the forex market seems rather tame to an ordinary eye. When you look at the most popular currency pairs, there are no crazy gaps like you often see with stocks.

Thanks to its liquidity and accessibility, forex can seem almost inactive as compared to other markets. Yet, looks can be deceiving. All over the world, around the clock, armies of analysts, associates and number-crunchers are compiling forex data for crucial reports.

These are the pieces of news that push the market, leaving a trail of traders with either riches or rags. Read on to learn more about what moves the forex market and how to prepare for these events.

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What is the Forex Market?

The foreign exchange market (forex) is the global market for currency exchange. Aside from the derivatives market, it is the world’s largest financial market, with trillions exchanging hands every day. It is also the most liquid of all the financial markets. Due to its decentralized structure, forex trades over-the-counter (OTC) 24 hours per day, 5 days per week.

Since foreign exchange quotes are ratios of one currency against the other, every transaction involves the simultaneous purchase of one and sale of another currency. This price is also known as the “rate” and it shows the value of a base currency compared to the value of another (counter) currency.

If you’ve ever traveled internationally, you’ve likely been concerned with the exchange rate. This is what we’re talking about.

For example, pitting Euro against the US dollar means you’re trading EUR/USD, while the US dollar is trading against the Japanese Yen as USD/JPY. Other major currencies include the British pound sterling (GBP), Australian dollar (AUD), Swiss franc (CHF), Canadian dollar (CAD) and New Zealand dollar (NZD). Some currency pairs have nicknames, with the most common being Cable for GBP/USD and Loonie for USD/CAD.

Along with the major pairs (the most liquid on the market), there are minor pairs. In these cases, major currencies trade against each other (e.g., EUR/GBP, GBP/JPY).

In addition, there are also exotic pairs when a major currency trades against currencies from small or emerging economies (e.g., US dollar and Thai baht — USD/THB). And finally, there are regional pairs — those bound by a region (e.g., AUD/NZD).

What Causes the Forex Market to Move

Consider these basic reasons for market movement. Remember, current events are happening every second, and any piece of news could cause the forex market to fluctuate. At other times, you might assume that the forex market will shift—but it doesn’t. Instead of assuming that the forex market will move or not, look for these indications that the foreign exchange market should be on the move.

Central Bank Meetings (Rate Decisions)

By far the most important news on the forex markets. As central banks conduct the monetary policy, they do so by setting the base interest rate. This rate dictates the interest for lending the money between the institutions, consequently controlling the economy’s money flow.

Central bank boards usually meet several times per year to vote on the rate policy. The options are to raise, lower or keep the rates put. Recent trends brought the rate to the lowest point in the U.S. after the Federal Reserve Bank cut the rate to 0 while stimulating the economy by making the financing cheaper.

Besides the Federal Reserve Open Market Committee, other key decision-makers include the European Central Bank (ECB), Bank of England (BoE), Reserve Bank of Australia (RBA) and Bank of Japan (BoJ).

Employment Data (Consumer Confidence)

Unemployment data is crucial as it gauges the overall state of the economy. While all countries periodically release this data, the most important employment news arrives on the first Friday of the month, when the US Bureau of Labor Statistics reports the non-farm payroll report. It shows the change in employment without taking the seasonal agricultural employment into account.

US dollar crosses usually experience wild swings during this event, as the worldwide market is digesting the news. It is not uncommon to see the price move over 1% in either direction.

Economic Growth (Investor Sentiment)

Every quarter, investors look for the gross domestic product (GDP) reports assessing the economy’s overall health. These reports show the annualized change in the inflation-adjusted value for all the goods and services created in the economy.

Since forex trades in pairs, it is enough for one country to miss its GDP estimates to trigger a violent reaction, as investors rally to sell it in favor of buying the more promising one.

Inflation (Gain or Loss of Buying Power)

A hot topic in recent times, inflation is measured by the change in the price of a standardized basket of goods and services. This index is called the consumer price index (CPI). This is yet another of the controlling tools for the monetary policy, as central banks monitor inflation for guidance to change the interest rates. While the data comes out monthly, it is often compiled into quarterly and yearly reports, often quoted as a year-over-year change.

Unfortunately, CPI is not the perfect measure as it suffers from 2 biases. First, there is a substitution bias as consumers tend to switch their purchases, depending on the elasticity of the demand. The second is a quality / new good bias as the basket tracks the price but fails to account for the quality improvements for certain goods. This is evident with some of the fast-developing tech products, like mobile phones.

Retail sales (Consumer Spending)

They are often used as a leading indicator because they are released monthly. Therefore, their effect is yet to be seen on macroeconomic reports like the quarterly GDP reports.

When consumers feel secure, they will spend more, leading to an increase in economic activity. However, if productivity and wages are not growing while retails sales are going up, this can be an indicator that people are stocking up for a slowdown. Thus, retail sales should not be the sole source of sentiment.

Research is Key

Quality research takes time and dedication. For forex, this is best done on the weekends, when the markets are closed.

Here are few guidelines to conduct actionable forex research:

• Keep a weekly news schedule: Look for high and medium-impact news and plan your trading schedule around that.
• Check the financial media outlets: Financial media often releases special reports and coverage ahead of the key market news. Sometimes this includes early estimates and analyst revisions. Take advantage of that material.
• Compare the seasonality effects: Currency pairs have seasonal tendencies which have been studied over the decades. Keep that in mind, as the seasonal effect is often acting like gravity.

Keeping an Eye on the News

While the market is moving most of the time ordinarily, several types of news reports mandate your attention.

If you are a day-trader, your morning routine includes checking the news schedule to avoid unnecessary risks. If you are a long-term forex trader, you need to monitor for fundamental news to manage your existing positions and preferably avoid entering new positions just before the news events.

This doesn’t mean that trading around the news cannot be profitable. But, for those who are not seasoned professionals, it often turns out to be like picking pennies in front of the bulldozer.

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