Currency Trading

Currency exchange rates i.e. the price or value of one foreign currency against another currency, are determined in one of two ways.

Fixed currency exchange rates – a fixed or pegged exchange rate is a rate set and maintained by a country’s Central Bank. In order to maintain the fixed exchange rate, the Central Bank must constantly monitor and intervene in the market. When the price falls it must buy sufficient of it’s own currency to drive the currency price back up to it’s fixed parity. Conversely, when the prices rises above its parity, it must sell enough of it’s own currency to drive the price back down.

Prior to World War I there were global fixed exchange rates as the value of the currencies of many countries was backed by physical gold. The use of gold in this way became known internationally as the ‘gold standard’. Britain, for example, adopted the gold standard in 1840.

Floating currency exchange rates – after the First World War due to inflation and recession the ‘gold standard’ was replaced by the Bretton Woods system which entailed partially fixed exchange rates. This arrangement worked for some time as currency exchange rates against the dollar, which was still pegged to gold, were agreed and fixed.

By the early 1970s, inflation in America and massive financial deficits caused by the Vietnam War and rising oil prices resulted in the demise of the Bretton Woods system. Currency Exchange Rates were now dictated not by gold but by market forces and many countries either supported their currency by intervening in the market or allowed them to “float” and to find their natural or perceived market value against other currencies.

Unlike the fixed rate, floating currency exchange rates are determined by the private market through supply and demand. A floating rate is often termed “self-correcting”, as any differences in supply and demand will automatically be corrected in the market.

In reality, currency exchange rates are neither wholly fixed or floating. In a fixed regime, market pressures can also influence changes in the exchange rate. Sometimes, when a local currency does reflect its true value against its pegged currency, a “black market” which is more reflective of actual supply and demand may develop. A central bank will often then be forced to revalue or devalue the official rate so that the rate is in line with the unofficial one, thereby halting the activity of the black market.

In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation.

Forex Pivot Points