The reasons for the movement of exchange rates in the Forex market. How do trends form?
Reasons for the movement of currency rates in the Forex market
The ratio of the value of currencies of different countries ultimately depends on fundamental factors. These are the efficiency of the economy, the cost of imports and exports, the movement of capital, and the like. However, the change in rates does not occur at once, but moves gradually. A currency rate is its price expressed in units of another currency. The market price always rises or falls. What are the reasons for the rise or fall in prices at certain intervals? It is very important for Forex traders to understand the impact of these reasons, as most trading strategies are based on following the price trend.
Why are prices moving
The term “trend” is known to everyone. With regard to the market in general, including the Forex market, this is the direction of price changes over time. To understand why a trend is developing, you need to understand what causes the quotes to move. This can be explained by the example of an auction. Buyers are offering higher and higher prices for the item put up for auction. Although it happens the other way around, when no one wants to buy at the offered price. Then the price goes down until there is a buyer willing to buy at that price. The meaning of this example is that prices change without concluding a deal, but only on the basis of bids from auction participants.
Likewise, prices displayed on POS screens are a display of offers from buyers and sellers. These prices are offered by market makers and are called liquid prices, that is, the market maker has enough currency to buy or sell. Therefore, in order to change the price in the terminal, it is necessary that the values of the supply and demand levels change.
How prices change
There are two options for changes. The first is when the liquidity provider changes its orders. Suppose at the moment he announces that he is ready to sell a unit of one currency for 1.2455 (the offer price) of another currency, but after a few seconds he already offers a price of 1.2460. That is, the price rose by 5 points, although there were no trading operations. The marketer simply changes the price of his offer based on his own considerations.
The second option, which determines the price movement on Forex charts, is caused by the absorption of market liquidity. On the chart or in the list of quotes, market participants see only the Ask and Bid prices that are closest to the balance. In fact, a large number of other Ask and Bid orders are located below and above the current market price. At all price levels there are orders of various volumes. Let’s say that at the level of 1.2460 there is an order to sell 1 million USD, and at the level of 1.2461 there is an order for any other amount. If the broker buys out the whole million from the market maker, then the price will move up one point. If the order is not fully redeemed, then the price will remain in place. In this example, price movement occurs as a result of a trade.
Trend formation process
Knowing the reason for the price change, you can understand why the trend is developing. Let’s say there are two traders, one of whom wants to sell one lot of currency, and the other wants to buy one lot of the same currency. The volume of liquidity with the prices of the bids will satisfy the sell order, and the buy orders take liquidity at the prices of the bids. If there are orders of the same volume on both sides, then only the spread will widen. If on one of the sides the order volume is less than the order volume, then the price will move to the level of the next order. That is, the direction of price change depends on the difference in the amounts of liquidity.
Suppose one liquidity provider offers to sell 5 lots of USD at its own price, while another exposes the same amount of currency at a price one pip higher. On the side of buyers, market makers placed several orders for the same lot at different levels. If a buyer and a seller appear with the same orders for 4 lots, then their orders will be executed, but the price will change. The point is that a sell order will not be fully executed, while a buy order will be executed at different price levels until it is fully satisfied.
Thus, it turns out that the high level of liquidity prevents price changes and even the execution of a transaction does not move it. Conversely, if the order absorbs liquidity at several levels, then the price moves rapidly in this direction. This property of the market is sometimes used by the Central Banks of some countries. They carry out so-called “foreign exchange interventions”, throwing a huge amount of liquidity into the market in order to depreciate their currency.
How the trend develops
The profit of independent Forex brokers, which are reflected in our rating of Forex brokers in Russia and the rest of the world, consists in the spread they receive from traders. Therefore, they need to buy and sell almost simultaneously to make the difference. The broker sells currency to a trader at one price, and buys from a liquidity provider at another. After the trade is executed, the liquidity decreases, and the next orders are executed at a different price. To avoid losses, market makers and dealers withdraw orders at a price that is unfavorable for them. The more traders enter with purchases, the more likely the price will move up.
This is a schematic description that only roughly explains the processes taking place. But across the entire Forex market, it is a powerful force that continues and develops itself, rapidly gaining momentum. On market charts, intraday trends can be seen as strong impulses. The price continues to rise or fall until the liquidity on the opposite side exceeds the supply or demand. This, however, does not mean that the market will reverse in the opposite direction. A strong impulse is followed by a pullback, and then the trend continues its development.
Knowledge of the reasons for price changes and trends can be used in technical analysis. In combination with other instruments, this will help in determining support and resistance levels, possible reversal points. Although in the Forex market, analysis of liquidity volumes is difficult. This is an over-the-counter market and does not have a single order book. However, some brokers, such as Oanda, publish such statistics in the form of charts. Depths of Market are also available in ECN systems of many ECN brokers, for example the popular Forex broker, which also offers an ECN trade execution model.