Forex traders might start out by focusing on their local economy and currency because they’re the most familiar financial constructs to them. If a trader lives in the UK, then the Pound Sterling and the state of the economy are daily topics in the trading news headlines, so it’s natural to view the Forex trading market through the lens of the GBP.
Traders are also likely to own their local currencies, having earned them or made funds from financial activities in their country. But when it comes to exchanging or trading the currency they’re holding, traders have to widen the lens and peer at the global economy. This is because currencies are traded in pairs and fluctuate according to each nation’s economic performance and position in the world economy.
Learning how each economy and currency fits into the bigger picture reveals the importance of the global economy in trading. Ignoring the conditions on the other side of the currency quote could result in problems and miscalculations when placing trades, so research is important.
Researching the global economy
The world’s economic ecosystem is a flourishing garden of major developed economies and emerging economies. Major economies like the US and EU show stable but uninspiring growth, having reached a mature size with organised infrastructures and well-established, experienced central bank and fiscal governing bodies.
Some of the biggest mature economies are members of the Group of Seven (G7), including Canada, France, Germany, Italy, Japan, the UK and the US. Together, they account for approximately 54 percent of global productivity, or an estimated 36 trillion GBP (2021 IMF figures).
Emerging economies include the BRIC nations: Brazil, Russia, India and China. Between them, they account for around 30 percent of global productivity.
It can be said that the world economy needs the stable supply and demand ecosystem in mature markets, but depends on the more volatile emerging markets such as China and Africa to drive strong growth.
What does this mean for Forex traders?
To break down a complex question into manageable parts, researching the global economy can reveal:
- which currencies are volatile,
- which currencies are strong or weak versus the base currency,
- why currencies move up or down within a given period,
- and where to find potential trading opportunities.
Which currencies are volatile?
As a general principle, a reasonable level of price volatility is an accepted and even desired condition in Forex trading. Returns are made on the differences in the prices of currency instruments like the EURUSD or GBPUSD, which are classified as major Forex pairs.
If an instrument trades sideways and there is not much change in the price, traders may not be interested in opening up a position. When volatility turns into turbulence, only the most experienced traders can handle it, and most would prefer to stay well away from such high-risk situations.
Like the story of Goldilocks and the Three Bears, volatility can be too hot, too cold or just right, depending on one’s appetite for risk.
Emerging currencies are more volatile than major currencies because of domestic growing pains such as a lack of prudent fiscal management, bloated inflation, over-dependence on one economic sector, government overspending and high debt. That’s not to say that mature economies don’t face their own imbalances, but rather that their existing infrastructure and experience helps them to adapt quickly with monetary policy and fiscal measures.
Which currencies are strong or weak versus the base currency?
To answer the question of which currencies are strong or weak versus the base currency, let’s assume the base is the GBP. An emerging currency like the Indonesian Rupiah would be weaker versus the GBP, so someone traveling from the UK to Indonesia would have spending power. Comparing GBP to the USD is a different story as both currencies belong to mature economies and trade relatively stronger or weaker against each other depending on economic developments.
Why do currencies move up or down?
Currencies move up or down because of the Forex market’s reaction to trading events and cyclical moments in the global and domestic economies. Weaker growth in the UK can often lead to a weaker currency versus other mature currencies, for example. When growth is strong, trading sentiment is confident and the currency is bought up, showing a bullish trend versus other currencies.
Currencies also move on central bank decisions, strengthening during hawkish periods and weakening during dovish measures.
Where to find potential trading opportunities?
Researching the state of the global economy can point to potential Forex trading opportunities based on growth patterns in emerging versus major currencies; relative weaknesses and strengths between major currencies; and currency trends triggered by central bank decisions.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.