I’ve been wondering what exactly determines the rise and fall of currencies. It looks complicated, but there are actually clues to follow. In the foreign exchange market, there are many factors that affect how a country’s currency price moves, but only a few matter the most.

I’ve organized these factors and found that they can roughly be divided into three time horizons. In the short term, pay attention to interest rates and market sentiment. In the medium term, focus on political risk, inflation, government debt, employment, and capital markets. In the long term, the key drivers are trade conditions and fiscal policy. Today, let’s talk about how all of these affect exchange rates.

First is political stability. Would you lend money to a place with an unstable situation? Investors think the same way. When a country is politically stable and the government is willing to improve people’s lives, the economy naturally grows, and the currency also appreciates. Conversely, when news of Brexit came out, the British pound fell sharply against the U.S. dollar—this is a typical example.

Next is interest rates. When a central bank adjusts interest rates, the market often reacts quickly. Raising rates means deposits and investments earn more interest; investors flock in, demand for the currency increases, and the exchange rate naturally rises. The Reserve Bank of India did this years ago by raising interest rates to prevent the rupee from continuing to fall.

Inflation is also crucial. Nobody wants to buy a currency that keeps depreciating. If a country’s inflation is far lower than that of other countries, its currency will appreciate. Zimbabwe is an extreme case: after inflation soared, the currency’s value shrank dramatically, and there were basically no traders willing to touch it.

Employment data reflects the true state of the economy. High unemployment indicates stagnation, causing the currency to depreciate. Every time the U.S. releases the non-farm employment report, the market swings significantly because the data directly affects the strength of the U.S. dollar.

Government debt also can’t be ignored. In a country burdened with debt, the ability to attract foreign capital is weaker, so the exchange rate naturally declines. Investors typically look at debt trends over several years to judge whether the country’s currency is worth investing in.

The performance of capital markets can reflect the overall state of the economy. A long-term decline in the stock market signals that investors lack confidence, while an upward trend suggests the possibility of currency appreciation. Since 2005, as China’s capital markets have surged, the USD/CNY exchange rate has also reflected these changes.

Market sentiment is a bit intangible, but its impact is very real. If everyone expects a particular currency to appreciate, investors will follow the trend and buy, which truly pushes up the exchange rate. Back in 2005, when the U.S. real estate market was booming, low interest rates fueled expectations that home prices would rise—thereby boosting the U.S. dollar.

Trade conditions are also worth watching. Countries whose exports exceed imports have strong currency demand, so their exchange rates can keep appreciating. China has largely positive trade conditions, which is why it has long been a hotspot for foreign exchange trading.

Finally, there are monetary and fiscal policies. If the government formulates policies that attract foreign capital, investors will pour in, increasing demand for that country’s currency, and its price will naturally rise.

Now you probably get it: the reasons behind currency appreciation and depreciation are essentially the result of these factors interacting with one another. Once you understand them, forex trading won’t seem so mysterious.