Got 100 On That B What You Know About Math Currency Trading – How the Value of a Currency Is Determined

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Currency Trading – How the Value of a Currency Is Determined

Have you encountered these questions before from your spouse, family and friends?

  • “Which currency will go up?”
  • “Which coin should I buy now?”
  • “I currently have some Australian dollars. Should I sell it now or keep it?”

This list is not exhaustive, but these were actual questions I received from different people in the past.

In this article, I go back to the basics of currency trading and address the question of how a currency’s value is determined. If you are new to Forex, we hope you find the following discussion helpful. If you are already an experienced forex trader, I hope you will still benefit from my sharing.

The currency is always traded in pairs

Believe it or not, there is no answer to the question”which currency will rise?“The reason is that currency is always traded in pairs. I’m sure most of you have gone on vacation abroad before. Remember your last trip abroad. You used your home currency to exchange currency of the country you were visiting based on the The rate of your money exchange? Did you do a currency trade? In essence, you bought the currency of the country you were visiting and sold your local currency.

As you can see, a Forex quote is always derived from two currencies. We use the Euro (“EUR“) and US dollars (“USD“) as an example. Let’s say EUR/USD is now 1.2500. This means that for every 100 EUR, we can trade for 125 USD. Conversely, for every 100 USD, we can trade for 80 EUR.

A currency pair is a fraction

A currency pair can also be viewed as a fraction. This means that we can use mathematics to explain the movement of a currency pair. I have found this method very useful whenever I need to explain this concept to novice forex traders.

Assume that C = A/B. The value of C will increase if one of the following occurs:

  1. when A rises but B remains constant;
  2. when A remains constant but B falls; or
  3. when A goes up and B goes down at the same time.

Now, if A is EUR and B is USD, the value of EUR/USD will increase if one of the following occurs:

  1. when the Euro strengthens but the USD remains constant;
  2. when the Euro is holding steady but the USD is weakening; or
  3. when the EUR strengthens and the USD weakens at the same time.

Now I hope you know how to ask your next Forex question correctly. Instead of asking the question “which currency will rise?“, the appropriate question to ask is “what currency couple hop on?” At all times, we are evaluating the relative strength or weakness of one currency against the other currency.

Use the law of supply and demand to explain the relative strength or weakness of one currency against another currency

The law of supply and demand in Economics is useful for explaining the relative strength or weakness of one currency against another. Consider the following scenarios. In both scenarios, we will assume that the money supply in country B remains stable.

Scenario 1

Country A decides to increase the interest rate to control the increase in the inflation rate. Generally speaking, when the interest rate increases, there will be an increase in demand for the currency. In this case, if the currency pair in question is expressed as A/B, we will expect the value of this pair to rise.

Scenario 2

Country A decides to increase the money supply to stimulate the economy and we expect this to result in an increase in business and consumer spending. In this case, if the currency pair in question is expressed as A/B, we will expect the value of this pair to go down.

Note that the above discussion has been simplified primarily for the benefit of novice forex traders. The world works in a much more complex way, which means there are many factors that need to be factored into this discussion. This deserves the space of another article in the future.

I hope most novice forex traders now have a better understanding of how they should ask their next forex question. At the very least, they should know that the right question to ask is “which currency pair will rise?” and no “which currency will rise?

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