What Determines Exchanges Rates? Here Are 6 Factors You Should Know When Trading Forex

Forex is an adrenaline rush & to be successful in trading requires anticipating the market, and every trader knows how difficult that can be. After all, what determines exchange rates?

It turns out a lot of things do. Here, we’ll explain the six factors you should pay attention to if you want to increase your profits.

How Rates Affect Traders

Rates affect everything for traders, but it really comes down to the most important element: making money.

Changes in the exchange rate mean increased or reduced profits when trading. They also help traders determine their risk/reward strategy, tipping them off when it’s a good time to sell or when it’s a better time to purchase.

Knowing and anticipating how exchange rates fluctuate leads to more money in a forex trader’s wallet.

What Determines Exchange Rates

There are a number of factors that determine exchange rates. We’ll look at six of the most important.

1. Terms of Trade

The terms of trade are demonstrated through a ratio comparing export prices to input prices. Higher exports indicate a greater demand for the country’s produce.

This hints at the country’s economy, which can cue traders into which currencies are strongest. It also increases that nation’s revenue, which increases currency demand and, finally, its exchange rates.

2. Inflation

One of the greatest factors impacting rates is inflation. Lower inflation increases a country’s purchasing power while also boosting currency value. Higher inflation has negative consequences on a nation’s purchasing power, as it depreciates the value of its currency.

3. Interest

Inflation and interest are closely linked. High interest rates spur foreign investment, which elevates the nation’s currency value.

However, low interest rates encourage consumer purchasing and maintain a healthy economy, which has positive influences on a currency’s value. When consumer demand outperforms supply, inflation occurs.

Working in tandem, these two elements are key characteristics in determining a nation’s exchange rate.

4. National Deficits

Another factor influencing rates is the national deficit. Countries that have high debt risk increasing inflation, which means its currency will depreciate in value.

For foreign nations, this is a huge red flag. If inflation continues to increase, a debt-riddled nation will reduce prices for trading countries. However, a foreign country may lose out if they invest in companies dominated by the weak currency.

5. Economic Strength

Economic turmoil results in less confidence in a nation’s currency, encouraging traders and other countries to turn to different monies. Comparatively, strong economies draw investors and traders.

6. Speculation

The market is full of speculation. Researchers and analysts attempt to determine which currencies will be valuable and which won’t.

Just as a blizzard warning causes consumers to rush to stores to prepare, so, too, does market speculation. If a country’s currency is expected to be strong, exchange rates increase in anticipation for the high demand.

Study the Nation

As you can tell, exchange rates are all about studying a nation and evaluating its stability. What determines exchange rates is ultimately what determines the overall strength of a country.

Thinking of forex trading? If so, read our article to discover how to be a successful forex trader. It takes research, practice and dedication.

This article was written by our in-house forex traders with a combined 20+ years of experience in trading the financial markets.