What affects the forex markets?

Politicians do not operate in a vacuum. While the words they use and the actions they take are significant, they are one part of a wider web of factors that can affect forex.

In this content, we've highlighted stories that demonstrate the things six key world leaders have said and done in the past 12 months, and looked at what happened to search volume and the currency market at the same time.

However, it's important to understand the wider context and factors that move the market when it comes to forex.

Fundamentally, prices move up and down based on supply and demand - just like any other financial market. Investors choose to put their money into an economy that has a positive outlook and strong growth potential.

News that points to this outlook or potential will, therefore, boost investment and drive up demand for the currency in the location. If demand goes up and supply remains steady, the price will increase. On the flip side, negative news could harm investment and reduce demand, leading to a fall in price.

Politicians can influence this news. However, the activities of credit agencies and reports from key economic bodies, for instance, are also important as are other unforeseen factors such as natural disasters, war and terrorism.

In general, therefore, the value of a currency is often linked to the economic strength of the country or region it is used in as a strongly performing economy is likely to have big demand for its currency.

Our partners at IG.com have broken up the factors affecting forex into short, medium and long term considerations as follows:

Short term: risk appetite, volatility, commodity prices, interest rates

Medium term: current account surplus/deficit, political risk, fiscal policy, bond yields, relative economic growth

Long term: purchasing power, net foreign assets, terms of trade.

Traders shouldn't underestimate the power of sentiment either. Once people start to get a sense that a currency price is moving in a certain direction, then they will trade based on this feeling.

Don't forget that supply can be an issue as well as demand. Through policies such as quantitative easing - common in recent years - central banks have the power to increase the supply of their currency and affect the price as a result.

The rich range of factors affecting forex helps to explain its volatility - and its appeal to investors.

To learn more about what it takes to trade forex, check out DailyFX's free online forex trading university.

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