The Forex market is far more active and fast paced than the
conventional stock market and a new investor needs to tread
with caution here. In order to be a successful trader in
the foreign exchange market, you need to know the basics of
Forex trading and what factors influence the market. Also
required is a substantial amount of research and study to
forecast and trade in the foreign currency exchange market.
Forex has the power to make or break your financial
standing in the market, so make sure that an experienced
Forex trader or broker is guiding you. In a highly dynamic
market such as Forex, the supply and demand forces
prevailing in the market affect the currency rates. At
times, the central bank is compelled to intervene in the
floating market to control the foreign currency exchange
rates. This form of intervention primarily occurs due to
pressure from external sources with an aim to stabilize
currency rate fluctuations.
In order to know the intervention techniques used, you need
to first understand why the bank is forced to intervene.
With constant fluctuations, it sometimes becomes difficult
to make investment decisions subsequently affecting foreign
trade. For instance, if the currency rate is so irregular,
an investor may be apprehensive of putting in more money
and may hold back his investments for a while. As a result,
the government or central back is forced to step in to curb
the fluctuating prices and encourage investors to resume
their investment activities. Bank intervention is also
required to stop or reverse trade deficit of a country, as
higher exchange rate will imply cheaper goods and services
meaning increase in imports. The central bank thus plays a
vital role in stabilizing the economy of a country.
The central bank may adopt either a direct or indirect
method of intervention. While the direct approach involves
trading currency in an effort to control market movements,
the indirect approach is used to make changes in the
domestic money supply. Among the two, the direct method is
more often used to intervene. There is a sudden drop in
currency rates as soon as the bank increases the currency
supply. Basically, currency value depreciates when the
supply increases and vice versa. Thus, when the bank wants
to raise the value of a specific currency, all it has to do
is purchase it in bulks to reduce the supply and increase
demand. However, direct approach has limited effects, as
the Forex market soon stabilizes and continues the previous
trend.
The indirect method of intervention is quite similar to the
direct approach wherein money supply is altered to control
the currency exchange rates. Value of currency increases if
the supply is reduced, on the other hand, the value drops
rapidly if the currency supply is increased. The indirect
approach may take quite some time to have a significant
impact of currency rates, as it needs to pass through
various market operations before it hits the exchange rate.
A major drawback of this method is that the central bank
has to change the domestic interest rate to make up for the
changing fiscal supply.
One thing you must understand is that intervention in the
foreign exchange market is not done too often due to the
drastic effects it may have on other domestic aspects. For
instance, change in fiscal supply will take a heavy toll on
rate of interest and cost of living. With high inflation
rates and equally high unemployment rates, the gross
domestic product growth will be seriously affected.
Financial experts believe that a "sterilized intervention
approach" is required to avoid these long-term effects.
This form of intervention is achieved when the bank
compensates for its direct intervention by making a
simultaneous change in the domestic bond market as well to
control currency rate fluctuations.
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Andrew Daigle is the owner, creator and author of many
successful websites including ForexBoost at
http://www.ForexBoost.com and
http://www.squidoo.com/forexboost/ , Free Forex Training
Resource for the Novice and Advanced Forex trader.
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