Recently, a friend asked me what exactly determines why a currency rises or falls. To be honest, it’s a great question, because many people trade forex without knowing the logic behind it.

I’ve found that the factors that affect exchange-rate movements can actually be viewed through three time dimensions. In the short term, interest rates and market sentiment fluctuate the fastest. In the medium term, political risk, inflation rates, government debt, employment conditions, and capital markets keep gaining momentum. In the long term, it’s trade conditions and fiscal policy that are the fundamental factors determining why a country’s currency rises or falls.

Let’s start with the short term. Changes in interest rates are the most direct tool the central bank has. When the central bank raises interest rates, investors can earn more interest, increasing demand for that currency—so the exchange rate strengthens. The Reserve Bank of India has used this approach to stabilize the rupee. On the other hand, market sentiment can instantly change the direction of the exchange rate. Sometimes, as soon as a rumor spreads, investors start to follow suit and buy, pushing the exchange rate higher.

Among the medium-term factors, the inflation rate is a very tangible indicator. Nobody wants to hold a currency that keeps depreciating, right? The lower the inflation in a country, the greater the chances of currency appreciation. Zimbabwe is the most extreme example: when inflation surged, the currency collapsed directly. Employment data is also crucial. A high unemployment rate signals economic stagnation, so the currency naturally depreciates. When the U.S. Non-Farm Payrolls report is released, the U.S. dollar index usually reacts noticeably.

Government debt is another factor that’s often overlooked. If a country is heavily in debt, foreign investors won’t dare to enter, and the exchange rate will naturally fall. The performance of the capital markets can also reflect how healthy the economy is. Long-term stock market growth usually signals currency appreciation. Since 2005, China’s capital markets have surged, and the appreciation of the renminbi is a good example.

In the long run, trade conditions determine the underlying fundamentals behind why a country’s currency rises or falls. In countries where exports exceed imports, the currency will keep appreciating because foreign capital needs that currency to buy the country’s goods. China’s trade advantages help the renminbi stay attractive over the long term. Political stability and fiscal policy are also important. A stable government can create a better investment environment, which naturally attracts more foreign capital inflows.

Once you understand these factors, when you look at exchange-rate fluctuations, you won’t only focus on the candlestick chart. What you need to look at is the economic side behind it, the political side, and also market expectations. Only then can you truly grasp the logic behind currency rises and falls.