What differentiates the Forex market from any other financial markets is the concept of currency pairs.
When a trader decides to take an FX position, the trader gains exposure to two varied currencies. This creates an opportunity for a trader to measure the currency strength of one value against the other.
This is why forex traders need information on currency strength on the most traded currencies in order to take a strategic FX position.
It is also important to note that the concept of currency pairs can very well complicate how you judge a currency’s performance when in isolation.
For instance, take the Pound/Euro currency pair (GBP/EUR). If the currency pair has positively gained on the day, is it because the GBP is performing well, or is it because the EUR is doing poorly?
Currency strength indicator
The existence of indicators is primarily to create a solution to the challenge of deciphering the currency strength of a currency in isolation. That is why experts came up with an online indicator referred to as a Currency Strength Meter.
The meter essentially operates as a visual guide to traders that demonstrates the currencies that are performing strongly at the moment and those that are weak currently.
These meters utilise FX rates of the different currency pairs to give traders information on the comparable and aggregate strength of each currency.
The basic meters do not always use any form of weighting as compared to advanced meters that make use of weightings. Some even combine currency strength measurement with other indicators to provide trading signals.
Therefore, to calculate the strength of the GBP, the meter would make a calculation of its strength by analysing all the currency pairs that contain the GBP like GBPUSD, EURGBP or AUD GBP among others. It then combines the calculations to come up with the overall result for the pound.
One good example of a strength indicator or meter is the Currency Strength Meter MT4.
What determines the strength of a currency?
There is a host of factors that determine the strength of a currency. The major factors that determine the strength of any currency include:
- Inflation: The value of a currency tends to rise when the inflation rate in-country is relatively low. Essentially, the lower the inflation rate, the stronger the currency. The existing relationship between exchange rates and inflation is that countries can practice fixed interest regime with the objective of controlling its inflation rate. This strategy may very well help governments control their inflation rate but it has its downsides including vulnerability to speculation and overall inability to undertake the domestic monetary policy.
- The strength of other currencies: Other currencies’ relative strength can affect the strength of a currency. This means that when there is an increase in the currency strength of any other currency for a variety of reasons, the value of the currency of the trading country will effectively decrease. The opposite is also true.
- Balance of trade: When a change occurs in the exchange rates of a country, it will be reflected in the country’s balance of trade. Therefore, when a currency strength increases, it will cause a responding drop in the import prices while increasing the export prices.
- Interest rates: There is a correlation between exchange rates and interest rates. When a country has higher interest rates, it will cause a corresponding increase in the exchange rates. This is because higher interest rates would attract more foreign capital and create more profits for lenders. Conversely, when a country’s interest rates are lower, the exchange rates will be lower too.
- Political factors: They are crucial in determining the strength of currency because foreign investors tend to look for countries that are politically stable before they make their investments. If a country is under political turmoil, the confidence in the country’s currency will decrease thus reducing its strength.
Which currency is strong today?
It might just be obvious to you that the strongest currency to you today is the GBP or the USD. You might want to reconsider.
The strongest currency today is actually the Kuwaiti Dinar.
(1 KWD = 3.29 USD). It is valued highest against the US Dollar. It is mostly attributed to the country’s heavy oil exports to the global market.
It is then followed by the Bahraini Dinar (1 BHD = 2.65 USD) than coming in in the third position is the Omani Rial (1 OMR = 2.60 USD). Something to think about, right?
This begs the question, what does strong currency mean? Currency can be termed as strong when it has general worth that is more than another country’s currency.
The strength of a currency is mostly weighted against the US dollar. For example, if the value of the USD is worth half GBP, the GBP is stronger than the USD.
Where is the dollar worth the most?
Some of the country’s where the value of the dollar can be felt most include:
- Argentina: $1 USD = 27 Argentinian Peso.
- Hungary: $1 USD = 278 Hungarian Forint.
- South Korea: $1 USD = 1114 South Korean Won.
- Thailand: $1 USD = 32 Thai Bhat.
- South Africa: $1 USD = 13.5 South African Rand.
- Iceland: $1 USD = 107 Icelandic Króna.
Who is hurt by a weaker dollar?
A weaker dollar only means that the currency’s ability to buy foreign goods or services is limited. This causes a rise in the prices of imported goods.
Therefore, the consumer is hurt most by a weaker dollar or a weak pound because they have to pay more for good or services when compared to a strong pound or dollar. The consumer is the ultimate sufferer when the currency strength of any currency depreciates.
What is the safest currency?
The safest currency in the world today is the Norwegian krone as opposed to the US Dollar or the pound sterling. This is because the Norwegian central bank is among the banks that have the highest capital ratios at 23.3% in the world.
Furthermore, the country has zero net debt, meaning that the debts are exceeded by the total financial assets. The fact that the krone is not pegged to any other currency makes it safe too because it cannot be dragged down when another currency’s value depreciates.