How Foreign Exchange Market Works?

Foreign Exchange Market Works

As we all know, there are risks in the foreign exchange market, so be careful when entering the market! With the continuous development of the society and financial industry, more and more people are beginning to pay attention to and participate in foreign exchange transactions.

Before you formally conduct foreign exchange transactions, you need to have an understanding of foreign exchange related aspects. Next, let’s talk about the operating principles of the foreign exchange market.

Foreign Exchange Market Works

Just like any other market in the world, the foreign exchange market works are driven by supply and demand.

In fact, in the foreign exchange market, the concepts of supply and demand are too important, so it is necessary for us to return to the “Economics 101 classroom” (the professional courses of European and American universities are generally taught in classroom 101) to ensure our learning progress the same.

Understanding the principles of supply and demand will make your foreign exchange investment career very different because it allows you to effectively filter the massive amount of information generated every day and find the most important part. So, how exactly does supply and demand affect the foreign exchange market?

Supply measures the quantity of a certain commodity that can be supplied in a certain period of time. The price of a commodity is directly linked to its supply. In this case, the commodity is money. When the supply of a currency increases, the value of the currency will decrease; conversely, when the supply of a currency decreases, the value of the currency will increase. Think about the difference between stone and diamond. Stones are not very valuable because they are everywhere. You can take a walk on the country roads, and you can choose hundreds of different stones along the way. Diamonds are different. They are very expensive because there are not many in the market. The current supply of diamonds in the world is very small, and if you want to buy it, you need to pay a high price.

Foreign Exchange Market Works

On the other side of this economic equation is demand. Demand measures the number of consumers who want to purchase a certain commodity in a certain period of time. The market demand for a currency will have an opposite effect on the value of the currency and the supply. When the demand for a currency increases, the currency will appreciate; conversely, when the demand for a currency decreases, the currency will depreciate. To better understand the impact of demand on commodity prices, you only need to know about Aimo Tickle Doll. This Aimo Scratch Doll was wildly sought after by the market as soon as it went on the market. Mom and Dad stepped on each other’s feet and robbed each other and paid before others might snatch it from their hands to make sure they had all the items on the child’s holiday gift list. For those who are unhappy or not strong enough, Yuanfa bought this doll from the mall, they had to pay a shockingly high price from eBay. The huge demand caused the price of this red silly doll to far exceed the price when no children wanted it.

Foreign Exchange Market Works

To illustrate how supply and demand determine a reasonable exchange rate in the foreign exchange market, we used a standard supply and demand diagram (see Figure 3.1). The supply curve is the solid line in the graph, sloping from the lower left to the upper right of the graph. The demand curve is the dotted line in the graph, sloping from the upper left to the lower right of the graph. The y-axis or vertical axis represents the price. The x-axis or horizontal axis represents the quantity of supply and demand. Therefore, the reasonable exchange rate is located at the point where the two diagonal lines intersect. In this example, the supply and demand diagram shows that the reasonable exchange rate for Euro million USD is 1.2100.

Regardless of whether it is an increase in supply or an increase in demand, all you need to do is to shift the corresponding curve to the right along the x-axis. So if supply increases, you shift the supply curve to the right; if demand increases, you shift the demand curve to the right. If the supply decreases or the demand decreases, you just need to do the opposite, and shift the corresponding curve to the left along the x-axis. If supply decreases, you shift the supply curve to the left; if demand decreases, you shift the demand curve to the left.

As we discussed, when the supply increases, the reasonable price of the commodity decreases. When the supply curve continues to shift to the right, it means that the supply continues to increase, and the price level corresponding to the intersection of the two curves is getting lower and lower. This tells us that a reasonable exchange rate is getting lower and lower.

when the supply curve keeps shifting to the left, it shows that the supply continues to decrease, and the price level corresponding to the intersection of the two curves in the graph becomes higher and higher. This tells us that reasonable exchange rates are getting higher and higher.

Shifting the demand curve to the left or right will have a similar effect on the exchange rate. When demand increases, reasonable prices will increase. So when you keep shifting the demand curve to the right, one by one indicates that the demand increases and the intersection of the two curves will become higher and higher

When you keep shifting the demand curve to the left, one by one indicates that the demand decreases, and the intersection of the two curves will become lower and lower.

When both the supply curve and the demand curve shift, you will see a dramatic shift in reasonable prices. For example, if the demand for a currency suddenly increases while the supply is decreasing, the reasonable price will rise rapidly (see Figure 3.6).

On the other hand, if the demand for a currency suddenly drops while the supply is increasing, then the reasonable price will fall rapidly (see Figure 3.7).

Supply and demand are synergistic.

Please take some time to confirm that you are really familiar with and understand the concepts of supply and demand, and how these diagrams represent the interaction between the two because we need to use these diagrams to explain why the foreign exchange market works and how you can learn from it Profit.

Volatility of the foreign exchange market

Understanding the volatility of the foreign exchange market is relatively simple, because the forces of supply and demand that you experience in your daily life also play an important role in determining the exchange rate of the foreign exchange market. Take oil prices as an example. When the demand for crude oil rises or the supply of crude oil falls, the price of crude oil will rise. When the price of crude oil rises, the prices of gasoline and natural gas also rise. When gasoline and natural gas prices rise, you will have to spend more when you drive to the city to buy and heat your house. And when you spend more and more on petrochemical products, your budget has less and less disposable funds. These factors that affect your budget will also affect the world’s largest companies and governments.

impact of rising oil prices

There is a country whose impact of rising oil prices is similar to its impact on you. This country is Japan. Almost 100% of the crude oil needed by Japan is imported, and its crude oil reserves cannot meet its needs, so it has no choice. Therefore, regardless of the price, almost all crude oil that Japan wants to use to produce electricity, automobiles, and other commodities needs to be purchased from other countries. However, this is only the beginning. Japan’s economy also relies on exporting goods to other countries, such as the United States. You may have noticed how expensive it is to drive to the city to purchase. It costs a lot of money to get the groceries you buy, your children, and yourself from one place to another. And when you have to ship your products to the other side of the Pacific, it will cost more. Shipping every car, DVD and computer produced in Japan to consumers is increasingly expensive. Therefore, Japan is suffering a double blow. He must import crude oil at high prices to produce goods, and then pay high freight charges to ship the goods.

So, what impact will rising oil prices have on Japanese products? Of course it is to make them more expensive. If Japanese companies have to pay higher costs to produce products, and then pay more to ship the products, the selling price of their products will naturally be higher because they can recover costs and make profits. If products become more expensive, consumers will buy fewer and fewer. When the number of consumers’ purchases decreases, the company’s profits will decrease, which will lead to various negative economic results. Now, let’s look back and see what all this has to do with the exchange rate of the yen.

Through the lens of supply and demand, you can see how rising oil prices will affect the value of the yen. Crude oil is priced and settled in U.S. dollars. When oil prices rise, Japanese buyers must convert more Japanese yen into U.S. dollars to pay their oil prices. An increase in the supply of yen in the foreign exchange market will reduce the value of the yen. When Japanese merchandise emerge as more costly and fewer human beings are capable to buy, the call for yen will lower, which will make the problem worse. Since you must use yen to buy Japanese products, you must sell whatever currency you hold to buy yen. The fewer products you buy, the fewer yen you need. And when you don’t need Japanese products, your demand for yen stops. The increase in supply and the decrease in demand has a direct result of the depreciation of the yen.

The impact of crude oil prices on the yen is just one example of how supply and demand affect the foreign exchange market. Will see many other fundamental factors affecting the foreign exchange market in future sharing. Now, the most important thing for you is to become familiar with the concepts of supply and demand as soon as possible. Once you have mastered this most basic and important economic concept, you will be overwhelmed in the foreign exchange market.

So, whenever you analyze the foreign exchange market, all you need to do is to ask yourself how supply and demand will be affected by everything happening around you.

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