What is behind the price movements in the forex market?

The price movements of financial instruments in forex and other markets are shaped by many factors. The most potent price driver of them all is the “interaction” between sellers and buyers – supply and demand.

To understand what truly causes price shifts, we must take a closer look at the behaviours of market participants, the role of volume, and the impact of liquidity:

1. Supply and demand

Price fluctuations are primarily triggered by the interdependency between supply and demand. For any trade to occur, there must be a corresponding buyer or seller (in a functioning market).

But it is the degree of intensity or willingness of traders to sell (or buy) at a specific price that significantly influences the speed and magnitude of price changes.

Tools such as On balance volume, Money flow index, Volume oscillator, etc. can help you assess the strength of buyers and sellers in the market, and speculate potential price direction.

2. Volume

The total quantity of transactions or trades executed during a particular timeframe. Volume is an important metric because it often correlates with significant price movements.

A high volume indicates strong interest, and potential price movements.

For example, a high volume during an uptrend can translate to heavy buying pressure and a continuation of the upward trend.

And a high volume during a downtrend can signal an intense selling pressure and the downward trend continuation.

Lastly, volume divergence is also a price direction indicator. When price moves in one direction, but volume moves in the opposite direction, it can imply a weakening momentum, a potential trend reversal.

3. Liquidity

Liquidity simply means how active a market is. It is how easy an asset can be traded without seriously affecting its price.

It is a very important indicator that affects volatility.

When markets possess sufficient liquidity, price movements can become relatively stable and slippage is minimised.

The reason is because a huge number of participants are actively trading, and there are always counterparties available at every price level.

A lack of liquidity often leads to surging volatility, slippage, difficulty in entering/exiting positions.

One vital aspect of liquidity that influences price movement is pending limit orders.

A large number of limit orders at a specific price level can create a “wall” that can temporarily halt price movement or cause sudden price spikes if the wall is breached.

Closely watching these elements can improve your understanding of price dynamics & enhance your trading decisions.

FAQs

How does price move in forex?

Currency prices move based on the fundamental principle of supply and demand.

When demand for a particular currency increases relative to another, its value appreciates.

And if demand decreases, value goes down.

What determines forex movement?

Forex movements are primarily controlled by market sentiment, global events, economic and political factors (These factors shape the perceptions and actions of traders & impact supply/demand and then price):

Economic factors: Interest rates, inflation, economic growth, and trade balances.

Political factors: Stability, government policies.

Market sentiment: Speculation and risk aversion.

Global events: Geopolitical tensions and disasters.