As the name suggests, The Foreign Exchange is the arena where currencies are exchanged. Most retail Forex traders place their trades in the Spot Market. Here, the currencies are traded in pairs.
You are buying a currency in exchange for another. You open a short position for a currency and sell it against another currency when you close that trading position.
The difference between the prices of the currencies that prevails during the exchange is the how to make your profit or incur a loss in the Forex Market.
The Major Currencies
There are three categories of currencies – “Major”, “Minor” or exotic. It depends on the liquidity or the trading volume of the said currency. The term “major pairs” is used for the most liquid currencies paired with the US Dollar.
The exotic pairs are ignored by most traders and we will exclude them from this chapter as well. These exotic pairs stir little interest because the markets which have the potential to cause low volatility trading conditions to have very little liquidity. Most traders divert their attention to the major USD pairs.
Have a look at the currency distribution table from Wikipedia from the year 2010:
The United States Dollar (USD)
The US dollar is famously known as the greenback. It acquires the title of being the most traded currency all around the world in every market. In the Forex Market, the major currencies are paired with the US Dollar and they form the “Major pairs” together.
Owing to the fact that the United States of America has the largest economy in the world and because USD is the unofficial global currency makes USD to have the highest trading volume. It is also a widely accepted currency in most countries.
Not only currencies, commodities like metals are also compared to the value of USD. For instance, gold and silver are also compared to USD value in the Forex Market like Gold (XAU/USD), SILVER (XAG/USD)
This is why any major political or economic news of the United States cause a ripple effect all over the global market. The USD has a pervasive influence on the global market’s dynamic with even small changes causing dramatic consequences.
To cite an example, the Non-farm Payroll announcement that comes every month in the US can cause major upheaval and volatility in the Forex market. Due to this, most traders avoid opening a new trade position during this time.
The Euro (EURO)
The Euro is a relatively new addition to the Forex Market history. Despite being one of the late additions to the market, Euro has managed to secure the position of being the second most traded currency globally. It is now counted as one of the major currencies.
For all the countries who are a part of the European Union bear EURO as their official currency.
The primary intention behind the fabrication of Euro was to establish a macroeconomic stability all across the European area. Additionally, there was also the intent to have a control over any future inflation
The foremost benefit that Euro promoted was that it completely eliminated the issue of currency exchange within the European Union enabling the constituent countries to easily exchange currencies with each other.
Every minor and major political and economic news of the countries that make up the European Union has the potential to influence Euro’s value.
The primary factors that influence the value of Euro include Central Bank policies, Interest rates, trade balances, inflation, debt levels and the cumulative GDP out of all the European countries.
The EUR/USD is the most traded currency pair in the spot market. This makes it the most liquid currency pair.
The Japanese Yen (JPY)
The Japanese Yen (JPY) comes in third as the most traded currency in the world. In fact, it is the most traded currency in the Asian market.
Most traders have an interest in the Japanese Yen because of the potential carry trade opportunity. To make it more attractive, the bank of Japan has set a zero interest policy. Most traders make a profit by borrowing the Japanese Yen and exchanging for some currency which has a high yielding value like the Australian Dollar.
The interest rate of the Australian Dollar is comparatively much higher. Traders make a profit form the difference in the exchange rates that accumulate overnight.
There is a huge demand for JPY in the Forex Market owing to its potential carry trade. A high demand for the Japanese Yen, in turn, increases its value. However, the Japanese economy depends substantially on the import/export sector of the country. So, a very strong Yen would make affect the sector and essentially suffocate the country’s economy.
To solve this problem, the Bank of Japan aggressively interferes in the Market to weaken the value of yen. All of this is done to increase the import/export sector of the country, thus salvaging its economy.
The Great British Pound (GBP)
Great Britain Pound (GBP) comes in the fourth position when it comes to the major currencies. It the currency native to the United Kingdom.
The United Kingdom is one of the countries of the Euro-zone. However, it has made a conscious decision to not adopt the EURO due to a long and rich history of the British pound. The British government controls the country’s domestic interest rates.
The country’s interest rates, UK trade balance, and demand for oil have a role to play in determining the exchange rate for the British Pound.
Crude Oil and Natural Gas gives a major impetus to the GBP. Unlike other currencies, crude oil prices fluctuate a lot and go up and down rapidly. This fluctuation of the crude oil prices has the potential to influence the exchange rates of GBP.
The Swiss Franc (CHF)
If you want to know which is the most stable and safest currency to trade in the Forex Exchange Market, it would have to be the Swiss Franc (CHF) which is Switzerland’s currency.
The inflation of the Swiss economy has the most pivotal effect on the CHF exchange rates.
The CHF is so valued for its safe reputation that even if the Swiss National Bank announces an intention to raise the interest rates, traders may sell their assets in other places to exchange it for CHF.
A whopping 40 percent of the Swiss currency is supported by gold reserves which makes it extremely attractive to the buyers. The CHF is affected directly as the value of gold escalates.
However, a new problem has risen owing to Swiss Franc’s immense popularity. The demand for Swiss Franc has increased the value of the currency so high that now it can potentially destroy the country’s import/export sector.
To combat this problem, the Swiss National bank has pegged the value of Franc to save its country’s economy and bring it to a stable state.
The Commodity Dollars
“Comm Dolls” is a term used to denote some of the major currencies whose values are extensively interrelated to commodities like God, Silver, Crude oil, and high-quality Copper. Supply and demand for these precious metals and crude oil heavily influence the valuation of the Comm dolls.
The Australian Dollar (AUD)
A number of prominent Asian countries trade extensively with Australia, China being its primary trade partner.
A sluggish pace of the Chinese manufacturers will affect the Australian Dollar directly. The Chinese manufacturers are aided by the Australian market for the supply of raw materials.
A sudden decrease in the demand for raw materials will cause them to become cheaper, thereby making the demand for Australian Dollars weak as well.
When the demand for raw materials is strong, traders can see a general increase in the valuation of the Australian dollar.
Australia has sizeable mines of precious metals in the country, so the value of precious metals like Gold and silver can also affect the value of AUD.
The Australian Dollar attracts carry traders from all around the world owing to the Reserve Bank of Australia’s decision to have the highest interest rates that are et across all major currencies.
The Canadian Dollar (CAD)
The Canadian Dollar is the official currency of Canada. It also is known as the Loonie.
Canada has the second largest reserve of Crude oil in the world. Hence, Canada is a commodity-based economy and the demand and supply of crude oil heavily affect the value of the Canadian Dollar.
The United States is the largest consumer based economy and being located in such close proximity to Canada, the US economy has a significant influence on the economy of its neighboring country.
In fact, the CAD has a high correlation to the USD. There is a high demand for Canadian crude oil in the USA. America is the biggest customer for Canadian crude oil.
However, traders are wary of trading the USD/CAD currency pair owing to the fact that crude oil is often subject to frequent fluctuations in the prices and there is a certain volatility to it.
Canadian Dollar is also influenced by the interest rates and central bank policies of the country.
The chapter makes it abundantly clear that a number of factors can influence the value of a currency, be it specific qualities of the currency, it’s commodity reserves or the influence of some other currency.
Any good trader who has some interest vested in trading must have proper knowledge about the factors that influence the major currencies. Bank Manipulation Trading, a tried and tested Forex Trading strategy focuses on the proper understanding of the market influencers.