Central Bank Interest Rate

At the macro stage, exchange rate values are no more influential than central banks and the interest-rate decisions they make. In a general sense, if a central bank increases interest rates, it means that their economy is rising and that they are positive about the future; if they are lowering interest rates, they are pessimistic of the future and that means that their economy is heading into tough times. It is possible that this kind of visualization is too simplistic, but it is typically the way central banks respond to changes in their economies.

The dilemma occurs as traders try to guess what the central banks are going to do with markets. Usually, when traders expect an interest rate hike, they start purchasing the currency long before the central bank is scheduled to decide, and vice versa if they expect the central bank to cut rates. However, if the central bank fails to do as traders anticipate, as traders leave their preconceived positions, the reaction may be very violent.

Most of the major central banks have administered more communication policies since the Great Financial Crisis of 2008 to more efficiently communicate to the market their plans for the near future. It could be a good time to buy the currency if a central bank tells you that they will increase interest rates earlier rather than later.

Central Bank Intervention

A currency’s value can often cause excessive damage on an economy to such an extent that the central bank of the nation feels the need to step in and directly manipulate the value in its favour.

A nation dependent on exports, such as Japan, for example, does not want to see its currency gain too much value.

They will otherwise have to lift their product’s selling price, which could have a negative effect on the amount sold. This creates quite a dilemma for exporters, particularly when their currency appreciates.

Central banks can exert their leverage by flooding the market with their currency by issuing previously unavailable currencies (reserves) and making them accessible to the public in order to offset their wildly appreciating currency. The rise in the quantity of currency available dilutes the value of the money already available and naturally devalues the currency.

It is especially difficult to take advantage of intervention because, unlike shifts in interest rates, intervention is not typically conveyed to the masses until after it has occurred.

Option

Most of the amount exchanged in FX options is for foreign business purposes, which means that the possibility of currency value shifts can be hedged by companies. A increasing portion of the amount traded, however, is going towards speculation.

The particular type of option that concerns FX traders most is the Double No Touch (DNT) option. Such types of options are generally put in common currency pairs such as EUR/USD or USD/JPY on round numbers and are frequently targeted by highly liquid investors. If a currency pair moves quite a bit and it reaches these psychological points of interest, often it rises above that level and then just as easily retreats away from it. Other times, before backing away from that amount, the market comes close, but never quite gets there.

Fear and Greed

Fear can turn a dropping instrument into an all-out panic in its simplest form, and greed can turn a growing demand into a blind-buying spree.

The relation between the two feelings can, too, go the other way. As fear dominated public thinking, the crisis in the Eurozone and, in particular, Greece, contributed to the drastic sale of the EUR currency in the 2010s. Soon after, however, speculation kicked in and forced the currency to levels that were harmful to jobs and inflationary dynamics, so much so that through a variety of market mechanics, the European Central Bank had to force devaluation.

While it may be easy to point out the impact of fear and greed on markets after they have acted on them, it is difficult to choose the moment when they flip into the current.

News

Some news is prepared and some isn’t, but in rather drastic cases, both can shift the market. Many investors are fawning over news that is planned and can drive markets on a regimented basis. There’s not much we can do about the unforeseen events; you simply handle risk and hope you don’t get adversely impacted.

Price fluctuations are not always planned news events. Part of the role as a trader is to know when, in addition to how to handle them, the big market-movers are happening. Jobs figures from major financial centres, for example, appear to drive markets more than a manufacturing sales report as a general rule, and a retail sales statistic riles up things more than a monetary supply report.

One of the main advantages you have as a trader might be knowing when the markets will change.