There is hardly any doubt that central banks are one of the cornerstones of forex trading because they set key interest rates and manage a country’s currency value. These institutions include the Federal Reserve System in the USA and the European central Bank, which are in charge of undertaking monetary policies that can alter the established worldwide flow of money. In the FX markets, traders and investors must turn their attention to the activities of the various central banks in order to make sound trading choices.
One of the most important central bank methods, through which they influence the forex market is through the rates of interest. When a central bank changes the interest rates of its currency, it influences the attractiveness for overseas investors. Higher interest rates lure investors in search of higher returns on their investment hence demand for the currency is pulled higher. On the other hand, when risk premiums are increased, by reducing the interest rate, which can lead to currency losing its value as interest is earned elsewhere. These are changes that professional FX traders have to keep an eye for because these can lead to large price fluctuations of the currency pairs in which they operate.
Monetary policies are also exercised by central banks to regulate the forex market. This consists of methods such as quantitative easing or tightening which involve putting money into or pulling money out of circulation. For example, when a central bank wants to employ the policy of purchasing more debts, often through purchasing the government securities it means expansion of the money stock. This may cause a devaluation of the currency as more money is especially in circulation of the economy. On the other hand the increase of money supply weakens the monetary policy while the decrease of money supply strengthens the currency. fx trading is often an unfortunate victim of these policies because traders assume positions based on the perceived movement of a currency.
But apart from interest rates and monetary policy, the central bank is also involved with the stabilization of financial markets in crises. Generally it is true that during cyclical or global crises, central banks can come in and participate in the market and use monetary policy to defend its currency. Such operations may involve purchasing or selling currency in the forex market. To FX traders, timing and reasons for a central bank intervention is equally important because it influences a dramatic change in the prices of a specific currency.
Additionally, the words of the director and president of the central bank are quite influential when it comes to the market outlook. In their speeches, especially the press conferences, central bankers use language that traders follow keenly, through comments on conditions in the economy, inflation, or prospect of an upward or downward change in policy. These comments bear useful information to the traders about the overbearing of the central bank and the direction of the particular currency in the short run. The speeches influence behaviour in the Foreign Exchange market by having traders enter at positions and switching currencies depending on the perceived shift in the policy.
Anyone in fx trading must learn about the central bank’s actions and decision making. Governments realize that central banks do not only impact the macro economy but also short term Embassy currency market equations. By studying these institutions one can predict the movement of these currencies and thereby enhance their chances of making a correct prediction on the new trends of forex trading.
