This article is contributed to us by Kelvin Wong, Senior Market Analyst at OANDA Asia Pacific Pte. Ltd.
The global foreign exchange (FX) market, the largest financial market in the world by trading volume, exerts a significant influence on global economic activity. Forex, or foreign exchange, is a dynamic marketplace where buyers and sellers engage in currency buying and selling at agreed-upon prices.
This intricate network serves as the conduit for individuals, corporations, and central banks to convert currencies seamlessly.
According to the Bank for International Settlements, the average daily volume in total over-the-counter (OTC) foreign exchange instruments (including spot, outright forward, foreign exchange swap, and option transactions) was USD 918.4 billion in April 2023.
This makes the forex market one of the most liquid of all asset classes and functions for 24 hours throughout a working week. With the advent of online trading, the forex market is now accessible to a broader spectrum of participants, encompassing financial institutions, governments, corporations, and individual traders. Before deciding on forex trading suitability, a comprehensive understanding of the market’s fundamentals is imperative.
In this article, I delve into three key characteristics of the forex market and explore the factors that influence it.
#1 The Market Is Liquid And Volatile
Many are attracted to the forex market for its notable liquidity, yielding minimal spreads, particularly in major pairs like EUR/USD, GBP/USD, and USD/JPY.
Yet, this dynamism comes with a caveat—forex is fast-paced and volatile.
Unlike stock market trading, currency markets respond swiftly to a myriad of events, with frequent data releases influencing currency movements regularly. While this bout of heightened volatility appeals to short-term traders seeking opportunities, it also poses the potential for losses due to rapid, unpredictable price shifts. Liquidity and volatility are not uniform across all currency pairs.
For example, the EUR/USD might be less volatile and more liquid than the USD/ZAR or USD/ TRY. Liquidity and volatility can also be impacted by the timezone in which the trader trades. For example, the liquidity of EUR/USD might often be better in the London and US sessions versus the Asian session.
#2 The Importance Of Economic Data
Macroeconomic factors, encompassing central bank announcements, interest rates, and inflation, wield substantial influence over forex markets. Geopolitical events and political instability, especially in less secure economies, also impact currency values.
Economic data, a gauge of an economy’s health, is pivotal for traders who scrutinize releases to inform their decisions. Another key fundamental factor to take note of will be interest rate differentials between two countries for example, the US and Japan that may dictate the movement of the USD/JPY in the medium term. If the interest rate in the US continues to trend higher versus Japan’s interest rate, it may lead to an appreciation of USD/JPY. In major economies like the US, UK, and Japan, a constant flow of economic data is available, yet sifting through this information to identify essentials is a challenge integral to successful forex trading.
As an example, the employment and payroll data from the United States, called the nonfarm payroll report, or NFP, is one of the most important fundamental data tracked by forex markets and likely to impact all major US dollar pairs such as EUR/USD, GBP/USD, USD/CAD, USD/CHF, and USD/JPY. It is critical for forex traders to therefore understand the intricacies of each data point and strategise their positions in the market accordingly, before and after the release of such data.
#3 Fundamentals Drive The Market In The Medium To Long Term
At the core of the forex market lies the fundamental factors such as interest rates, GDP and inflation data, exerting profound influence on currency movements. The extensive depth of the forex market comprises individuals and entities that speculate on currency movements based on these fundamentals.
For instance, if the US Federal Reserve takes a more assertive stance on interest rates, and the US economy demonstrates resilience compared to others, it’s expected that the US Dollar is likely to outperform other currencies.
Traders often employ a blend of technical and fundamental analysis. Yet, for longer-term strategies, a comprehensive understanding of how fundamentals shape the market proves invaluable. A good understanding of fundamental factors enhances the ability to anticipate market movements in advance, hence providing a deeper insight into potential market behavior.
One thing that may surprise some is that Singapore is the third largest FX centre globally after London and New York, and is the largest in Asia Pacific. If you want to learn more, I was recently on the DollarsAndSense Market episode to share more insights about the forex market. You can watch the full video on YouTube.
About OANDA Asia Pacific Pte. Ltd. (OAP)
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Disclaimer
Leveraged trading carries a high degree of risk and may not be suitable for everyone. Losses can exceed deposits. This article is for general information purposes and is not investment advice. It does not address the specific investment objectives, financial situation or particular needs of any person. Advice should be sought from a financial adviser regarding the suitability of any investment product before investing or adopting any investment strategies.This advertisement has not been reviewed by the Monetary Authority of Singapore.
