Recently studying the foreign exchange market, I found that many people do not have a deep understanding of the reasons behind exchange rate fluctuations. In fact, the factors influencing foreign exchange are far more complex than most think, and cannot be judged simply by looking at one or two indicators.

I have organized a framework that divides the factors affecting foreign exchange into three time dimensions for clearer understanding. In the short term, interest rate changes and market sentiment are the main driving forces. Once a central bank adjusts interest rates, investors' attraction to that currency immediately changes, which is why the forex market often experiences sharp volatility when non-farm payroll data is released. Market sentiment is even more interesting; sometimes, just an expectation or rumor can trigger large inflows or outflows of capital.

In the medium term, factors influencing foreign exchange include political risk, inflation rate, government debt, employment conditions, and capital markets. Brexit is a typical example; political uncertainty directly led to a sharp depreciation of the pound. Inflation rate is also crucial; if a country’s inflation is significantly higher than others, investors will naturally shift to buying low-inflation currencies, which will push down that country’s exchange rate.

In the long term, trade conditions and fiscal policy are decisive factors. If a country maintains a long-term trade surplus, indicating strong export competitiveness, this will continuously support its currency appreciation. For example, China’s past favorable trade conditions are one of the reasons the renminbi has attracted foreign investment.

Honestly, once you understand the logic behind these factors affecting foreign exchange, you won’t be scared by short-term fluctuations. Countries with strong political stability, friendly interest rate policies, and good employment data tend to have more popular currencies. Conversely, countries with high debt and economic stagnation are more likely to see their currencies sold off.

I think the most easily overlooked factor is market sentiment. It’s intangible but immensely powerful. Sometimes, an optimistic expectation can drive large capital inflows, and vice versa. Therefore, when trading forex, you need to look at both fundamentals and feel the market’s pulse. Only then can you better understand the rules governing exchange rate movements.