In order to make predictions traders need to know how the price is created, and what influences or changes it.
Prices are influenced by many factors, including political, economic, social stability of the countries involved and their monetary policies. It’s almost impossible to take every single one of them into consideration, so there are definitely some risks involved.
However, given that Forex transactions are immediate, the factor that most of all affects the market price is speculation. If traders speculate, for any reasons or events, a currency will weaken or strengthen. The higher the number of people convinced that a certain event will occur, the more the effect on the price will be, and it will change because many will decide to buy or sell that particular currency.
In fact, the market price meets at the point where supply and demand forces meet.
How to exchange CURRENCIES
To invest in currencies we look into currency pairs (i.e. EUR/USD, USD/JPY, etc.) that can be purchased or sold. A pair of currencies is divided between the base currency and the counter currency: the base currency is the first one.
An operation on a currency pair means buying a currency and simultaneously selling another.
For instance, let’s say we place a buy order on the EUR/USD currency pair.What happens here is that we buy the base currency (Euro) and at the same time sell the counter currency (USD). If, on the other hand, a sell order is placed, it means that we sell (Euro) and at the same time buy (USD).
A buy order transaction is soon after closed by a sell order transaction, vice versa a sell order transaction is closed by a buy order transaction.
Although we refer to two individual currencies, the ratio is considered as a single unit. In other words, the trading currency is the currency pair, not just the EUR or just the USD.
How is the price formed?
In order to understand how a market price is made, it’s important to understand that two traders need to conclude each exchange: one willing to sell at a price and the other willing to buy at the same price.
If the parties willing to buy are equivalent to those willing to sell, the price remains fixed. If the parties willing to buy are larger than those willing to sell, the price will move upwards, as long as buyers will be willing to conclude the exchange at a higher price than the current quotation.
Conversely, if the parties willing to sell will be larger than those willing to buy, the price will move down, until sellers will be willing to conclude the exchange at a lower price than the current quotation
Comparing this to exchange rates on the currency markets, the rates are affected by economic/fundamental, psychological, and natural occurrences. Depending on how the major players of the markets perceive the effect on a countries economy determines the exchange rate.
The major volume of trades occurs in the inter bank, where large banks speculate amongst themselves through electronic networks. These large banks that carry out over the counter speculations, often time determine the exchange rates through the forces of demand and supply. Other market players include central Banks, hedge funds, corporations, and Individual investors.
the Analyst's answerJean Grossett - Financial analyst
Trading is a zero sum game, what this means is that in order to place a buy order, there must be someone willing to place a sell order at the same price. What this implies is that oneperson’s win is another person’s loss.
Unlike the stock marketwhere a particular stock’s prices is determined by the interaction between traders and dealer. Whenever there are more buyers than sellers or vice versa, this creates a widening in the stock price. The dealer decides to close the spread depending on which team has the larger volume of orders by adjusting either the ask or the bid price. This leads to changes in the exchange rate.