Supply and Demand
In Forex trading, you will see that technical indicators (charts, moving average lines, etc.) are very important for determining how currency prices move. Of course, fundamental analysis (economic data, current events, etc.) is also useful for predicting how a currency price will change. Underlying the fundamental and technical methods is the basic economic principle of supply and demand. In the free marketplace, prices can change dramatically from changes in the supply of a currency and differences in the demand for a currency. This principle also applies to stocks, bonds, and commodities. Keeping this concept of supply and demand in your mind can keep your forecasting and predictions on track.
The Demand Factor
At the most fundamental level, a currency price will change because there is more or less demand for it. More demand means the currency pair will experience a higher price. Less demand means the currency pair price will fall. An example of increased demand for a currency is economic data suggesting a strong economy while demand for a currency could decline if the central bank lowers interest rates. True price movement is based on the demand for the currency. In fact, currencies rally when demand increases.
The Supply Side
A basic economic principle of supply shows that the value of a currency will change as the levels of supply rise and fall. A larger supply of a currency will diminish its value and price. A lower supply of a currency will increase its value and price. While the supply side is important, look to the demand factor as the primary moving force behind a currencys value and price.
Focus on the Demand-Supply Model
The trader must remember that real price movements are based on the level of demand for a currency. So currency prices are easy to predict, right? Wrong! A host of factors affect the demand and net supply for a currency. Everything from current events to the weather can affect the supply and demand for a currency. Think back to the Internet boom in 2001. People around the world wanted to participate in this booming industry centered in Silicon Valley. Demand for the US dollar soared. Supplies grew tight. The value of the dollar sharply increased.
Long-term vs. Short-term
Long-term supply and demand usually refers to a time period of a year or more. Short-term is typically thirty days or less. The same factors can affect currency prices in both time periods. The trader should be aware of the time factor in which a trade is placed. Long- and short-term price movements can run parallel. However, they can also diverge, leading to inconsistent price movements. Hence, you should always remember the trading environment and the time frame when making your Forex trade.
Determine which Factors affect Supply and Demand
The next step is to examine the broad categories of factors that can affect supply and demand. Most of these factors are fundamental, but technical factors can also affect supply and demand. Focusing on the factors that affect demand will keep you grounded and eliminate much of the trading noise and distractions that can impair your forecasting skills. It will also prepare you to interpret any event and analyze its impact on the long- and short-term price of a currency.