The Forex (or foreign currency exchange) market is one of the largest and most liquid markets in the world. Investors make or lose money on the fluctuations in exchange rates between different currencies. This is something almost everyone already understands about the Forex market, but knowing how exchange rates are determined and how they tend to operate is a complex matter which traders need to understand.
Currency exchange rates have a long and fascinating history and traders can benefit from a knowledge of how they came about, how they work and most important of all, how to profit from this knowledge.
This exchange rates report will fill you in about how to do this.
Let’s start with defining what an exchange rate is. This is the relative value of one currency compared to another. Let’s use the US and Canadian dollars as our example:
Suppose that the value of $ 1US equals $ 1.20 Canadian. This gives us an exchange rate of 1:1.2, or 1.2 for the CAD/USD currency pair.
With this established, what do exchange rates actually mean and how is it that some currencies are worth more than others? Who makes the call on which currencies are more valuable?
In the past, the value of most currencies was tied to the value of gold, silver and other precious metals.
The US used to follow the Gold Standard. the dollar’s value was tied (or “pegged” as it is also known) to the value of an ounce of gold. As the US came to be one of the world’s most powerful economic players, other countries pegged the value of their currencies to the US dollar. The values of these currencies were permitted to move no more than 1% from that of the dollar.
This largely immovable model of currency exchange rate is called a fixed exchange rate.
The US has long since stopped following the gold standard and with it, the fixed exchange rate. The foreign currency exchange uses a fluctuating exchange rate model, which is exactly what it sounds like – the value of currencies are determined by the laws of supply and demand.
We can see this in action with the US dollar. To keep pace with spending, the US Federal Reserve prints more money, increasing the supply and sells this money to other nations in the form of debt.
The US has lost much of the economic factors, such as oil exports which historically gave strength to the US dollar as a currency. This means that not only has the US dollar’s value in terms of exchange rate declined but so have the exchange rates of our largest trading partners.
The Japanese Yen has fared particularly poorly as of late, falling further than our currency. This is due both to more widespread economic turmoil in Asia and the reliance of Japan on exports to the US for its economic growth in the last several decades.
Market forces affect the exchange rates of all world currencies; the above examples serve as an illustration of how exchange rates fluctuate in response to the global economic picture.
You can get a hands-on lesson in how exchange rates work in the real world by opening a demo account with an online Forex broker. You can do test trades to see for yourself how the market operates and see the current exchange rates of different world currencies.
Traders should always keep up with the events that affect currency exchange rates. Stay informed about world events and business news from around the globe and you’ll start to see how exchange rates are related to what’s going on in the news.
By 3dman_eu from Pixabay