Why are central banks so key to the forex market – and what should you be looking for as a trader?

Forex is a complex beast, and that’s generally due to its unique style of volatility. In these markets, you are not so much betting on whether or not stock will go up or down in value, but on how currencies will perform against each other on the world stage. For example, a strong pairing might be USD/GBP, but if GBP suffers at any given point, you may find yourself out of a lucrative deal.

However, there is more to forex than just taking a look at how different currencies are performing. As you may already know, central banking plays a crucial part in forex, period. Why exactly this is the case, however, might not be too clear.

As a trader, there are likely to be plenty of things you need to consider before you go ahead and make any investments. For example, it may be worth considering using a Plus500 demo account if you are completely new to the markets.

In addition, it is a very good idea to understand a little more about how central banking and forex work hand in hand. Here’s a guide on how this all comes together.

Without central banking, forex wouldn’t work

It is safe to say that the work of central banks dictates forex performance in general. This is because central banking effectively underwrites the terms and rates that would normally alter the value of different currencies and pairings available for you to trade.

Crucially, central banks are independent, but are relied upon to set fair inflation and commercial interest rates. Effectively, central banks establish monetary policies and open market expectations. The key to the whole operation is, of course, to make sure that a given nation has stability in their given currency.

It is partly thanks to the strength and versatility of the Federal Reserve that USD continues to be a strong option in many pairings. In fact, many forex traders follow the Fed closely to ensure that they are up to speed on the latest financial decisions that may impact and alter their portfolio choices.

Why are central banks so important to forex?

As established, central banks effectively set the rules and can determine the crucial values you’ll find on the wider market. Their aims are to cultivate stability and to attempt to make pricing and interest rates as predictable and as steadfast as possible. At the same time, central banks also work hard to stimulate economic growth.

This is all great news for forex, as central banking is continuously focusing on achieving better rates and on bolstering their national credit. For example, anyone keen to invest in USD pairings will rely on the long-term decision-making of the Fed – as poor decisions could lead to instability and financial loss.

This is only a simple working example, as USD is still considered a fairly immovable object when it comes to the threat of volatility in forex.

It’s also worth noting that central banks also have a say in managing employment rates in their given nations, as well as in setting interest rates for wider banks and financial operations. Therefore, it is a safe assumption that they have a lot of power.

What should forex traders be looking for?

Forex traders who are just getting started, and who may be looking for a reliable, lucrative pairing to help ease them into the market, may wish to compare different central banks for decision-making and any precedents. While these banks are reliable for the most part, each central bank has different operating procedures, and naturally, you can expect different performances from global currencies from day to day.

For example, the way that the Bank of England runs matters may be very different from that chosen by the European Central Bank (ECB). Both have their relative strengths, particularly as London is still seen as a financial capital on the continent (Brexit notwithstanding), and the fact that the ECB caters to financial control across the whole of the EU.

Without central banks, forex traders would have much less data and much fewer precedents to pay attention to. It is, ultimately, the central banks that set the rates. Without this centralization, forex would be a wild guessing game – and given that global currency values are already volatile based on political and world events, more volatility is hardly going to be very inspiring.

Forex traders should take the time to follow news on behalf of central banks through their chosen pairings. Once traders have pairings set up that they would like to invest in long term, they should make sure to keep a close eye on financial breaking stories and events. As mentioned, politics also has a big part to play, which means that traders should also balance this with monitoring breaking global events.

For those traders who are looking for simple trading opportunities, forex may be a little too complex or even demanding. However, it is still hugely lucrative if you monitor the appropriate channels.

Will these links between forex and central banking ever change?

It is highly unlikely that central banks will never have an effect on forex. For as long as forex revolves around fiat currency on a global scale, the influence of central banks will always be difficult to ignore. However, in the grand scheme of matters, it is hard to understand why people would necessarily want to avoid learning more about their processes.

Forex is complex yet rewarding. Thanks to central banks, there is stability in even the most uncertain of times – which, again, is why USD proves to be so popular. It is one of the safest investments with regard to pairings worldwide.

Forex remains hugely appealing to traders all over the world. While cryptocurrency trading may eat a little away at the popularity, there are no reasons why you can’t balance portfolios in both markets.

This article does not necessarily reflect the opinions of the editors or the management of EconoTimes