How is such an exchange rate actually determined? In this article, we introduce the mechanism of foreign exchange trading that influences the rate.
What is Forex Trading?
First, let’s talk about foreign exchange trading.
Forex trading is simply a transaction that exchanges different currencies between two countries. This includes not only exchanging the Canadian dollar for foreign currencies such as the US dollar, Australian dollar, euro, pound, and Swiss franc.
When exchanging Turkish lira for dollars in a transaction, for example, it is called “buying dollars” or “selling lira”, and exchanging US dollars for Turkish lira is called “buying lira” or “selling dollars”.
Exchange rates and interbank markets:
The given rate is the exchange rate when exchanging currencies. Forex trading is basically a bilateral transaction that is carried out directly by the traders, so it does not matter if the exchange rate is agreed upon by each party.
However, that would be a problem if there are too many different transaction rates. For example, a company’s stock price is usually priced in that country’s currency. It stands to reason that Canadian companies use the Canadian dollar. However, when an overseas investor wants to buy stocks of a Canadian company, how much is converted? Without a rate based on a certain standard, the value will be difficult to determine.
Therefore, in the case of the exchange rate of foreign exchange trading, the rate in the “interbank market” where banks trade with each other is usually used. Like stocks, this rate is determined by the balance between supply and demand for transactions conducted by banks and dealers.
Exchange rates reflect the country’s economic strength:
The exchange rate fluctuates depending on the balance between the supply and demand of currencies. For example, if the exchange rate was 100 Canadian dollars per US dollar in a transaction between the Canadian dollar and the US dollar, it could be that a lot of Canadian dollar is bought therefore 1 dollar would equal 100 Canadian dollars. As a result, the Canadian dollar will appreciate and the dollar will weaken, therefore a lot of US dollars will be bought for 1 dollar.
This exchange rate is said to indicate the economic power (currency strength) of a particular country. There are various factors that change the level of the exchange rates. They are listed below:
Interest rate differential and Economic trends:
Interest rate differential and Economic trends and prices are called “fundamentals” and are factors of the country’s economy. Other factors include economic growth, the balance of payments, and foreign exchange intervention.
Political stability means that the exchange rate fluctuates due to political instability caused by war or terrorism, or statements made by politicians.
Actual demand is when a company trades foreign exchange through commercial transactions such as trade and capital transactions. In addition, hedge funds and speculative transactions by institutional speculators may also cause fluctuations in exchange rates.
How do you trade in the forex market?
Where are the currencies traded? Newspapers and television often use expressions such as “New York market.” However, in the case of currency, there is no dedicated exchange like stocks. In most countries, currency exchange financial institutions trade directly and indirectly through telephone and electronic networks. These are collectively called the “foreign exchange market”, or “forex” for short.
How is the actual transaction done?
You may have seen people around a round table trading while muttering something into the microphone when the news of the dollar exchange rate is broadcast on TV. The person in charge (broker) of the foreign exchange broker receives a buy/sell order from a bank or the like and matches them to complete the transaction.
Why does the market move?
The “price of money” changes, why does this mysterious phenomenon occur? Prices for cars and vegetables for example are determined by supply and demand. If more people want to buy the product, the price will go up, and if more products are supplied than the buyer demands, the price will go down.
If you have traveled abroad, you probably have the experience of exchanging the dollar for the currency of your visit before departure. And when you return to the dollar after returning, you may have experienced a “profit” or “loss” if the exchange rate was different from that before departure.