Trading

5 min. reading time
4/18/2019

What influences the financial markets?

There are a multitude of asset classes that are suitable for trading. To trade the markets successfully however, a certain basic knowledge of the markets is necessary. Take a look with us at the forex and equity markets and the factors that influence them.

What influences the financial markets?

Forex Market

With a daily trading volume of 5 trillion US dollars, the forex market is one of the most liquid markets in the world. Forex trading involves trading individual countries currencies against each other.

Factors influencing the Forex markets

Exchange rates are determined by supply and demand in the same way as share prices. There are many factors that have an influence,  the main factors include: gross domestic product, key interest rates, labour market data, data on foreign trade balance and political events.

Here are a few examples*:

The gross domestic product (GDP) measures the total value of all goods, i.e. goods and services that are produced domestically as end products during one year. If the GDP rises, this usually indicates a soaring economy and can mean an increase the value of the domestic currency.

Central banks control economic development by changing the key interest rate. If a country’s central bank raises the key interest rate, the result is usually an increased capital flow into the country, for example in the form of government bond purchases or other investments due to the more attractive interest rates. Investments that are made in the respective country will be in the national currency, this drives up demand for the currency and of course strengthens the currency. On the other hand, a reduction in the key interest rate theoretically results in an increased capital outflow as investors look for more attractive interest rates at which they can invest their capital, which in turn increases the demand for other currencies and thus weakens the domestic currency.

Labour markets data can also influence the Forex market. If unemployment figures rise, the central bank tends to be more inclined to lower interest rates in order to boost the economy (which may result in the aforementioned). Low interest rates mean more investment on the part of companies and increased purchasing power on the part of private individuals, which in turn can also benefit the labour market.

Import and export figures also have a direct impact on the foreign exchange market. For example, a positive foreign trade balance (exports > imports) would usually lead to an appreciation of the domestic currency, as importers have to buy the goods in the respective currency of the exporting country, which increases demand.

Political events such as elections and wars can also have a considerable influence on the domestic currency. For example, the value of the Mexican peso fell drastically due to the threat of a trade war and the construction of a border wall when Donald Trump was elected US president in 2016.

These small examples illustrate how diverse and complex the factors influencing the development of currency pairs can be. In addition to hard facts such as economic data, the expectations of institutional market participants regarding the development of relevant factors and their trading activities also have an influence on the Forex market that should not be underestimated.

Equity Market

The equity market is a market in which companies issue shares of equity capital and investors can trade these. By issuing shares, the company receives capital that can be used for investments and enabling further growth. In return investors benefit from company profits, e.g. in the form of dividends and, if necessary, rising share prices at which the securities are later resold.

How is a share price actually constructed?

A share’s price is determined by supply and demand. If there are more buyers than sellers, the price of the shares rises, whereas a falling share price is caused by a lack of demand or an oversupply.

Demand and supply in turn are based on many different sets of data. These include business-relevant figures such as quarterly reports, general company news and takeover bids. External additional factors such as changes in exchange rates, economic developments, the foreign trade situation and investor sentiment can also have an impact.

Quarterly reports and forecasts: As a rule, forecasts that exceed expectations lead to a share’s price to increase, while forecasts that don’t achieve expected forecasts tend to lead to a fall in a share’s price. It is quite possible however, that forecasts or expectations are already factored into the price when the reports are published.

Rumours or news about a takeover often lead to an increase in the share price of the target company, as capital flows into it and/or the demand for freely available shares increases. The acquiring company, on the other hand, tends to lose value as capital is required for the acquisition.

Other external factors are also important. Is the business model profitable in the long term? What do the competitors do? Which industry does the company serve and which trends does the industry follow?

Changes in exchange rates can also lead to changes in share prices. If the currency in which the stock is denominated is rather weak, foreign investors are more inclined to invest in the stock because the investment is cheap. In addition, a weaker currency can lead to better sales figures for the product abroad, which can go hand in hand with an increase in profits and thus an increased attractiveness for the shares.

On the other hand, a strong currency can lead foreign investors to withdraw their investment or to declining sales figures abroad having a negative impact on the share price.

If the economy is doing well, this usually also has a positive effect on share price. Economic developments and data such as labour market data, GDP or foreign trade data should therefore always be kept in mind when analysing share prices.

Labour market data: The lower the unemployment rate, the higher consumer spending can be expected, which can benefit companies and thus boost share prices.

An expected positive GDP stands for economic growth, which can lead to better results for listed companies and in turn to higher demand for shares. Whereas an expected negative GDP can lead to weakening share prices.

In addition to more rational factors, i.e. influences based on hard facts, the general mood of market participants also has a significant influence on the stock markets. The main issue here is expectations for the future and how these are assessed.

 


This information should not be interpreted as investment advice or any recommendation.

*All examples are for demonstrative purposes only and do not constitute advice or investment advice. Real market situations may differ.

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