In our last lesson we finished up our module on the logistics of forex trading with a look at the free real-time charts available in our demo practice account. In today's lesson we are going to start a new module on what moves the forex market with a look at something which is known as trade flows.

As most of you are aware, when the market for something is allowed to operate in an unrestricted manner, price is set by the intersection of supply and demand. This means that if there is more demand than supply for something then price should rise. Conversely if there is more supply than demand for something, then price should fall. When supply and demand are equal then price should stay the same.

Currencies are no exception to this basic economic concept. At its core the value for a free floating currency is determined by the demand for a particular currency in relation to its supply. While this is a simple concept, determining what the supply/demand situation for a particular currency is, and trying to forecast changes in that equation, is a little bit more difficult of a proposition, and is what currency traders who focus on fundamentals try to ascertain.

With this in mind ,whenever anything happens such as an increase or decrease in the amount of goods and services imported or exported by a country, an economic news release, speech by a fed official, or geopolitical event, a currency trader will always ask the question: "How does this affect the supply demand situation, and therefore the value of the currency that I am trading?"

In order to keep this straight in our heads its best to think of things that can affect the supply/demand equation as fitting into one of two categories. The first, which we are going to discuss in this lesson, is what is known as trade flows. Trade flows are anything that involve money moving in and out of a country as a result of global commerce. This basically means money flowing out of countries as a result of goods and services being imported from other countries, and money flowing into countries as a result countries exporting goods and services to other countries.

When a country imports goods this adds currency of the importing country to the market and creates demand for the currency of the exporting country. The reason for this is that the goods are normally bought in the currency of the country where they are produced, so the entity importing the goods must exchange their currency for the currency of the entity that is exporting the goods.

As an example lets say that a US Corporation is importing 1 Million US Dollars worth of steel from a Canadian steel producer. In order to purchase this steel, the US Corporation must pay the Canadian corporation in Canadian dollars. As the US Corporation most likely does not have cash sitting around in Canadian Dollars, they will go out into the market and sell US Dollars and buy Canadian dollars.


As you can see here, the buying and selling of currencies which takes place as part of this transaction, creates an increase in demand for Canadian Dollars while simultaneously adding supply to the market for US Dollars. While a transaction of this size would not have much if any affect on the market, if this type of transaction was multiplied many times over, you could see how the two currencies of the countries involved in the transactions would be affected.


In general countries which rely heavily on imports will see a weakening affect on their currency as a result of this, all else being equal, and countries who have economies which are more export oriented will see a strengthening affect as a result, all else being equal.


That's our lesson for today. In our next lesson we are going to learn about the second category of market moving flows which is known as capital flows so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!

Hi Dave

Awesome site for any trader

But something that is key in the FX market is the moving (strengthing/weakening) of currencies

So, if I understand this tutorial correctly on exporting, importing and trade flows

- Heavy Importing Countries -> Weakens that country's currency

The word weakens is the key here. We prbl need to look at an example..weaken in terms of other currencies?

If we take a example of USD/JPY and we focus on the importing of USD, if we keep everything else the same and look at the importing factor only, ...the more and more USD imports the "weaker" USD is going to be against JPY...

Thus if we start with USD/JPY say at 120.00 and USD is importing more and more goods from JPY, this exchange rate will then rise to 122.00, 123.00 ...and so on ?

Hi Oegma,

Thanks for the compliment I am glad you like the site.

I like where you are going with this as I agree that this probably needs more explaining and some examples will help.

To answer your first question yes when I say a currency gets weaker I mean against another currency or currencies depending on the situation.

You are correct that generally if everything else remains equal and a country begins to import more goods then their currency should weaken against other currencies.

In your specific example of the US importing goods from Japan you are also correct that if everything else remains equal and the US begins to import more from Japan then the USD would be expected to weaken against the JPY.

If this were to happen the exchange rate would however move down not up as you have stated below. Remember from our lesson on How to Read Forex Quotes that the rate you see in the window is how much it takes of the second currency in the pair to buy one of the first. So if the USD is weaker then it should take less Japanese Yen to buy 1 USD and therefore the rate should move down.

Hope that helps. Please feel free to post if anything is unclear or if there are any other questions.

Best Regards,
Dave

Is that an informedtrades.com golf shirt.???....If so...how can I get one...???
Jerry

Hi Jerry,

Yes it is an InformedTrades Polo that I where in the video. We are going to be adding this to the InformedTrades store soon but in the meantime you can purchase one here if you would like. The Polo that I where in the videos is the one on the right.

Best Regards,
Dave