In order to steer through this maze successfully, foreign exchange traders should become familiar with the forces that drive this market. Although there are many traders who insist that market drivers, or causes of price fluctuations, are unimportant because everything is already reflected in price action on the charts, it would be a grave mistake to ignore the fundamental roots of market movement. As will be discussed further in Chapter 4 on fundamental analysis, knowing what moves the forex market is integral to becoming an informed, and therefore well-equipped, foreign exchange trader.
The primary movers of currency exchange rates are all tied to the basic forces of economics, as will be described in detail within Chapter 4. For now, though, a simplification of the cause of currency exchange rate movement can be said to relate directly to the process of international capital flow. This is simply the movement of money from one currency to another. International capital flows, in turn, are caused by basic economic supply and demand factors.
As will be expounded on in Chapter 4, supply and demand are determined by a number of different factors. Most notably, these factors include a country 's interest rates, inflation situation, GDP growth, employment, trade balance, and other barometers of economic health. If demand for a currency increases (and/or supply decreases) as a result of one or a combination of these factors, that currency 's exchange rate will generally increase in relation to other currencies. Conversely, if demand for a currency decreases (and/or supply increases) as a result of one or a combination of the factors above, that currency 's exchange rate will generally decrease in relation to other currencies. It is a simple concept, but one that is not so simple to utilize in attempting to forecast market directions.
Aside from the fundamental market drivers just described, technical factors are often overlooked or underestimated in their ability to help move the forex markets. Although this will all be discussed in great detail in Chapter 3, a brief explanation here will help illustrate the point.
Traders in many banks, hedge funds, and other potential market-moving institutions will often use certain techniques of technical analysis to help them make trading decisions. These traders all have access to the same price charts. Furthermore, these charts all show the same patterns, key price levels, and technical phenomena, with perhaps just some minor differences due to variations in the traders ' individual interpretations.
This means that these influential players are generally all seeing the same types of technical events on the charts, which will often prompt many of them to buy at a similar price level, as well as sell at a similar price level. When a great deal of institutional money is on the same side of the market at the same approximate price level, prices can and will be influenced in one direction or another. In fact, this phenomenon of collective trading activity by influential market players is considered one of the primary causes of support and resistance levels being respected so precisely in many instances. One of the most significant concepts in foreign exchange trading, support/resistance will be explored in much more detail in Chapter 3, which covers technical analysis.
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