Traders make billions in the forex market due to FX currency exchange rate fluctuation. In this article, we will understand the types of currency rates, factors affecting these rates and how to interpret these rates to make maximum profit while trading in forex.
What is the currency exchange rate?
An exchange rate is a rate to measure the value of one currency with respect to another currency. In simple words, the Foreign exchange rate helps to determine the value of the currency in comparison to another currency.
Let us understand it with the example; suppose you want to buy a football, so to buy it, you have to pay the money of the ball’s worth.
Suppose the worth of a Football is 1 US Dollar.
So if you are paying in euros, you have to pay 0.91 euros as per the present forex exchange rate.
A quick glance
An exchange rate is a rate to measure the value of one currency with respect to another currency.
- Fixed Rate
- Flexible rate
The exchange rate is affected by different factors, such as its natural resources, technological development, import and export, inflation, interest rate, political state, etc.
- Learn Basics
- Identify the pair
- Understanding Forex rate
Understanding FX Currency Exchange rate
In the above example, we have to understand currency value with respect to a football. Now let us understand the concept of buying or selling one currency with another.
Currencies are exchanged for different purposes by travelers, students, and business personalities. Suppose you are traveling to the USA from the UK.
Now to survive in the USA, you have to exchange Pounds for US Dollars, as people in the USA will not accept pounds. As per the current forex rate, 1 GBP = 1.27 Dollars.
So when you exchange GBP with USD, you will receive 1.27 Dollars for every pound. Suppose you want to exchange 200 GBP, then you will 200* 1.27, which means you will receive 254 USD against it.
Now the question is how will you determine the value of one currency with respect to another?
The answer is the exchange rate. Just look at the exchange rate chart or search it on the internet. Each currency pair has different currency exchange rates. These rates change over time due to various technical and fundamental analysis factors.
As we have studied above, currencies are exchanged for different purposes. One of the major reasons for currency exchange is trading. Traders invest in the currency to take advantage of exchange rate fluctuations.
Types of FX Currency Exchange rate
Fixed Rate: It is also known as pegged exchange rate. When the value of one currency is correlated with another, a change in one currency’s value causes a change in the currency of pegged countries.
In other words, when the weaker currency is pegged with a stronger currency. The related currency caused the change. In order to deal with this situation, the central bank or government maintains a fixed rate.
Countries, to maintain this rate make changes in foreign exchange. Suppose the interest rate of stronger currency rise, so the countries pegged with it also increase their rates.
Flexible rate: It is also commonly known as the floating exchange rate. Under this, the exchange rate is determined by supply and demand rather than by the central bank or government.
Due to the constant change in the demand and supply, these rates keep fluctuating. Generally, major economies use floating rates, and weaker economies use fixed rates.
US Dollars, Japanese Yens, UK’s pounds and Europe’s euro are common examples of currencies with fluctuating exchange rates.
Factors affecting FX Currency Exchange rate
The country’s currency depends on different factors, such as its natural resources, technological development, import and export, the standard of living of its people, poverty rate, etc.
Due to changes in these factors, the currency’s value also changes. The stronger the country’s economy, the stronger the currency; the weaker the country’s economy, the weaker the currency value. Have a look at these major factor that causes exchange rate fluctuations.
Political state: The currency’s value is highly affected by the political state in the country. Government rules and regulations, political turmoil, and diplomatic relations cause exchange rate fluctuation.
Good diplomatic relations, flexible regulations, and political stability cause a positive change in the currency and vice versa.
For example, suppose the residents of China are protesting against its current government. Now it has a negative effect on its currency.
Debt ratio: Countries usually take loans from international organizations and other developed countries to develop their infrastructure and several other reasons. Generally, the debt of developing and underdeveloped countries is more than others.
A country’s income needs to be more than the debt to maintain its currency’s value. Otherwise, it results in inflation, and the currency value depreciates.
You may have heard the news about the situation of Bankcorruptcy in a country. It happens when there is an economic collapse in the country. Traders will not invest in a country dealing with the economic crisis.
Supply and Demand: The concept of forex currency exchange rate fluctuation is simple. When the demand is more, supply is less, and currency value appreciates; when the demand is less, supply is more, and currency value decreases.
The demand for its currency will be more than in other countries where thousands of travelers, students and business personalities visit daily.
Not only this, but the production power also affects currency value.
For Example, China is one of the biggest economies in the world. The reason is simple; it exports thousands of products daily and globally.
High Inflation: At present, major economies are dealing with high inflation. It is a state where a country’s buying power or purchasing power decreases with respect to other countries.
For example, for buying a bread loaf, you are paying 10$, which before a month was available for 4$. There is a huge difference between prices that also in very less duration.
If the price of the loaf increases in point, then it might be a case of an increase in the worth of the loaf. But in this case, there is a difference of 6$ in the price, which means that your currency depreciates against the good.
It is a clear case of inflation. That’s how the FX Currency Exchange rate fluctuates. Countries with higher inflation have weaker currencies, and countries with lower inflation have stronger currencies.
Market Movements: Traders indulge in Foreign currency trading, buying and selling currencies pair based on their prediction to make money. When speculators buy any currency in large numbers, it appreciates its value and vice versa.
The USD/EUR currency pair is the most traded. As a result, these two are the strongest currency in the world. Traders, daily, invest in this currency pair.
How to read and interpret FX foreign exchange rate
Learn Basics: The first and simplest step is learning how to read a pair. For example, in GBP/CAD, GBP is the Base currency, and CAD is the quote currency. The difference between the pairs will be the spread.
Identify the pair: There are more than 170 currency pairs, such as JPY/EUR, EUR/USA, GBP/CAD, etc. Monitoring all the pairs is impossible, so first, select a currency pair you are willing to trade.
Understanding Forex rate: When the exchange rate increases, it means the base value appreciates against the quote currency, and when it decreases, it means the quote appreciates against the base currency.
Suppose the currency exchange rate of EUR/USD is 1.10. It means that 1 EUR is equal to 1.10 USD.
Interpretation: Generally, traders interpret currency rates to take advantage of price fluctuations similar to gold, stock, and other financial trading.
You can use technical and fundamental analysis indicators to interpret the exchange rate. You have to monitor the above factor continuously to predict the currency movement.
After studying these factors, if you believe that the value of the base currency will rise, you will buy the pair; if not, you will sell the pair.
The currency value measures a country’s economic status and wealth. Currency is the medium to trade, travel and live globally. The stronger the currency, the more advantage and vice versa.
So it is essential to maintain the currency value. It is a must to keep an eye on all the above factors that cause changes in the FX currency exchange rate.
These rates are important not only for forex traders but also for individuals who indulge in traveling, import and export activities, etc.