# How currency exchange rates work

As of 2019, the Forex market sees a whopping \$6.6 trillion in daily trading volume. It is one of the most important financial markets in the world. The Forex market is an integral part of the global economy, and understanding how it works will give you an edge over other traders. Thanks to the development and spread of the internet, the Forex market is joined by new traders every day, increasing the market’s daily trading volume.

In order to trade successfully you need to understand how Forex works, and it is especially important to know how exchange rates in the global currency market work. So, let’s dive in and find out.

Contents:

Interact with the underlined words and green dots to get additional details and explanations.

## What is a currency exchange rate?

In simple terms, an exchange rate is the value of one currency against the other. It can change depending on a number of factors, which we will discuss below. To denote the exchange rate of the value of one currency against that of another, the term currency pair is used.

.The first currency that appears in the pair is the base or transaction currency, while the second currency in the pair is the currency used to determine the value of the base currency.

Currencies in a pair:

1⃣️ Base currency

The first currency that appears in the pair.

2⃣️ Quote currency

The second currency that appears in the pair, used to determine the value of the base currency.

The position of a currency in a pair pair shows that we are talking about the rate of the base currency relative to the quoted currency. For example, the  EUR/USD pair is equal to \$0.9985, meaning that one euro is worth 0.9985 US dollars.

### Types of currency rates

A currency’s exchange rate can be floating or fixed (pegged to another currency).

🌊 Floating exchange rate

This means that the exchange rate depends on the supply and demand of both currencies.

🔒 Fixed exchange rate

A fixed exchange rate is generally determined and regulated by the local central bank. Sometimes, a nation’s central bank pegs its own currency to a foreign currency, which means that its price moves depending on the exchange rate of the currency it is pegged to.

### How currency is exchanged

Currency exchange is carried out in three main ways:

1. The purchase and sale of currencies is carried out online or offline by financial organizations represented by banks.
2. On the stock market, which enables earning on differences in exchange rates

Olymp Trade users can trade on currency pairs in both the Forex and FTT modes.

## The most popular currency pair

Now, let’s take a look at how two currencies interact with each other when paired ⬇️

The currency pair  EUR/USD is the ratio of the euro to the US dollar. In this pair, the euro plays the role of the base currency, and the US dollar is the currency that is quoted. This currency pair is one of the most popular in the Forex market. You can easily trade the EUR/USD pair on Olymp Trade in Forex and Fixed Time Trades mode.

On the chart, we can see that the  EUR/USD pair is below parity and on a bearish trend, as the European Central Bank was late in its response to inflation compared to how quickly the United States Federal Reserve tightened its interest rate policy.

The price is clearly volatile — it goes up and down multiple times, giving us a handful of opportunities to get some of the action.

## What determines a currency’s exchange rate?

Many factors influence the dynamics of currencies’ price formation. Let’s take a look at the main ones:

📍 Supply and demand

Like in every market, supply and demand are the main factors dictating prices. When there is a strong demand for one currency over another, its price increases, and vice versa. Supply, in this case, means the total amount of the currency in circulation. Of course, central banks can use interest rates and printing to control supply, and along with other banks, they control most of the market. Demand refers to the number of traders, companies or investors willing to buy a currency.

📍 The economy

If a country’s economy is healthy, its currency is valuable and people are willing to invest in it, thus creating more demand and driving up the price. The demand for a certain currency may change depending on the rate of inflation, the state of the industry, the interest rate level, the value of the currency in the world and the country’s balance of payments, among other factors.

📍 Central banks

A central bank can affect the supply of a currency and use other tools to influence the global currency market.

📍 Various events

Unforeseen disasters and geopolitical events on a state’s territory and outside it can have a strong influence on its currency. A geopolitical event such as a war will affect the currency exchange rate of the countries involved. Additionally, the aggressor in the conflict can be faced with sanctions from other countries, which negatively affect its trade deals and economy, and thus its national currency.

Step 1️⃣

Open an account on Olymp Trade and deposit funds (or use a demo account).

Step 2️⃣

Open the Assets section and select Forex mode.

Step 3️⃣

Select the Currencies tab.

Step 4️⃣

Analyze the market with the help of tools and indicators and choose a currency pair to trade.

Step 5️⃣

Step 6️⃣

Choose the amount of leverage (multiplier) and define Stop Loss and Take Profit levels.

Step 7️⃣

Open an Up or Down trade.

Find out how to open an account on Olymp Trade and start trading in our detailed tutorial.

Step 1️⃣

Open an account on Olymp Trade and deposit funds (or use a demo account).

Step 2️⃣

Open the Assets section and select FTT mode.

Step 3️⃣

Select the Currencies tab.

Step 4️⃣

Analyze the market and choose a currency pair to trade.

Step 5️⃣

Step 6️⃣

Choose a trading time. Most assets in FTT mode are traded for 1 minute, but there are also trades from 5 to 15 minutes.

Step 7️⃣

Open an Up or Down trade.

## Analyzing exchange rates: A real example

The best traders combine fundamental and technical analysis to trade Forex. Let’s use both to analyze the  USD/JPY currency pair.

For the fundamental analysis part, we need to know the situation of both the US economy and the Japanese economy.

We know that the US Federal Reserve is aggressively hiking interest rates to fight inflation. Therefore, the demand for the US dollar remains strong because other countries are not increasing their interest rates as fast as the Federal Reserve is.

On the other hand, the Bank of Japan has a low interest rate policy, which means the Japanese yen will remain low.

For the technical analysis part, we can see that  USD/JPY is on a bullish trend but already reached an all-time high, so we expect a slight correction to meet the blue trendline, around the \$135.95 level. After making this analysis, we can conclude that the dollar is still strong, while the yen is getting weaker.

As seen via our analysis, we can conclude that the dollar is still strong, while the yen is getting weaker. In a short-term period, the  USD/JPY pair might drop, so a successful Down trade is very probable at this level. For the long term, however, the USD will remain strong, as the same fundamental conditions mentioned earlier remain.

Read more: Basics of trendline strategy

## Move forward with Forex

Currency exchange rates can be very volatile, which presents opportunities if you know how to spot them. If you want to delve deeper into benefiting from the global currency market, we recommend checking out our article on volatility and how to benefit from it as well as the top five Forex trading strategies.

Olymp Trade has the most popular currency pairs available as well as everything traders need to ensure their own success. Even beginner traders can learn to trade Forex, whether that be alone or with the help of Olymp Trade Blog’s useful educational material.

Learn, trade and become a real force to be reckoned with on Olymp Trade.