The currency market is the most liquid market in the world, with around 4.5 trillion dollars traded every day, which is more than the whole world’s GDP for one month. If we look at this market from a distance we see how difficult it can be to try and work out what market forces drive price movements and what causes a specific currency pair to move from one price level to another, only to see a few hours later the price go back to where it was as if nothing has happened.
We can say that the main factor influencing the price of a specific currency pair is the supply and demand. Every second of the day there is an entity or an individual changing currency somewhere in the world and different currency pairs continually change hands based on the supply and demand for the currency. The currency market players are central banks, financial institutions, banks, corporate hedgers and business involved in international trade. An example of a business changing currency on a regular basis would be companies involved in international trading whether, its export or import. Think Toyota paying attention to the relative value of the dollar versus the yen when they sell huge amounts of cars in America. This type of company would change currencies regularly, and in some cases might not wait for a good price if they have to convert the currency at a certain time for business purposes which cannot wait till the exchange rate is more favorable to them. Another example would be travel agencies paying one another invoices across the globe. On an even smaller scale, this about travelers and tourists who are always changing currencies for daily expenses. Also, we should never forget ourselves, the currency speculators – who buy or sell based on our expectations of future price.
All market participants play a collective role everyday in price determination for different currency pairs. The main factor that is derived from all these daily transactions is supply and demand. Sometimes bad economic news or economic data released from a certain country can arise and a temporary move in the market price could take place caused by speculators. If the bad news leads to expectations of price decrease, the market will be flooded with excess supply from speculators selling, and increased supply leads to decreased price. Once the news effect is over market forces of supply and demand would rule the currency market again and the price movements will be influenced by that.
For an example of a news release that affects the market and then fades away, we can look at the EUR/USD chart of yesterday, September 19th, 2011. Around 6PM EST news was released that Standard and Poor’s had downgraded Italy by a notch and kept its outlook as negative. Immediately the EUR/USD pair slipped around 70 points. Several hours later, during the following trading session, the pair made up for the losses incurred on the previous day and market forces prevailed. Supply and demand at its simplest.