How The Forex Works - What Causes Currency Changes?

When trading Forex it is important to understand the causes of currency changes on the Foreign exchange. By being aware of what is going on in the world you can apply it to your trades and avoid poor trade choices and take advantage of situations where you could make a profit.

What Causes The Currency Changes?

The value of Country-A's currency relative to that of Country-B is a measure of the inflation in the economy of Country-A versus that of Country-B. Almost all the world's economies are subject to inflation. That means the values of all the world's currencies decrease with time. In stable (democratic) economies such as the U.S., UK, western European countries, Japan etc. the rate of inflation is typically between 1 and 3 percent per year.

In countries with an unstable economy, (usually dictatorships) the inflation rate can be very much higher. For example the rate of inflation in Zimbabwe is over 1,000 percent per year. So one Zimbabwe dollar is worth less than one tenth of what it was a year ago, and a loaf of bread costs about a million Zimbabwe dollars.

Even in countries with stable economies, many factors can influence the inflation rate and hence the value of the currency. For example the sub-prime mortgage crisis in the U.S. in 2007, together with a record number of foreclosures has resulted in about 3 percent drop in the value of the U.S. dollar. The study of factors that influence a country's currency value is called fundamental analysis.

It is important to find out something about the countries whose currencies you intend to trade. For example: Do they have stable governments? Do they have a history of civil unrest? Are they subject to worker strikes?