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How Are Forex Rates Determined?

The monetary difference between the values of two foreign currencies is the forex rate. It is similar to the currency exchange rate that is set by competing banks and other providers of financial services in major tourist destinations like Paris and Miami.

Financial institutions of all sizes, from sovereign central banks down to small credit unions are constantly reviewing currency rates, particularly the local rate against the United States dollar (USD) in order to provide liquidity and options to their clients.

Supply And Demand

Forex rates are mostly set by the economic principle of supply and demand. In some cases, forex market speculators also have an effect on global rates, but not as much as some people may claim. Major geopolitical events and the way sovereign economies unfold have a greater influence on forex rates. Such was the case of the Tequila Effect of the mid-1990s, when the economy of Mexico nearly collapsed due to a sudden and deep devaluation of that North American country’s national currency. Forex traders closely watched the USD against other currencies to ensure that the Tequila Effect did not end up ruining their trades.

Watching Forex Rates

The most fundamental activity tied to forex trading involved watching the rates. Retail traders with modest balances should keep in mind that millions of people around the world could be watching forex rates at the same time they do, and some of those people are economists, major hedge fund managers, and powerful figures in central banks.

The way supply and demand interacts with the forex rates is the need for a common currency when conducting international trade. The most international trade is the USD, followed by the basic monetary unit of European Union member nations, the euro (EUR). Those two currencies make up the most heavily traded currency pair in the world: USD/EUR. This also happens to be the most closely watched forex rate.

Forex Rate Quotes

Forex rates are quoted by market operators at a certain price basis known as the bid/ask price. The spread between the bid and ask price is what traders speculate on, and it may differ slightly from the rates offered by local banks. Forex rate quotes indicate pips, which are basis points of the USD and fractions of a cent.

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