In economics, the simplest model to explain a free, competitive market is that of supply and demand . The price of merchandise is fixed at the point where the amount of demand equals the amount on offer – the market balance.
Who is the best person to guide you on understanding the market balance? Forex brokers are skilled with great analytical thinking. They can help you understand this concept. If you are a beginner in Forex trading, it is then important to choose your broker wisely by doing a simple Forex broker compare.
Understanding Supply and Demand
Let us assume that you are on the way to shopping. You need apples and there is only one apple dealer who stocks just the right amount of apples. They negotiate, agree on a price and carry out the exchange: an agreed amount of apples for an agreed amount of currency. You and the seller have successfully completed a deal in which both parties have achieved their desired goal.
The next day, you plan to buy the same amount of apples again, but you find two apple sellers selling identical apples, each with the amount of apples they need. This means an excess supply , the demand for apples is lower than the supply. There is competition between the two sellers, both of which reduce the price, assuming that they will buy the cheaper apples. A new, lower market price will level off and they will thank the free market for the fact that their nature made their purchase cheaper.
Alternatively, they could go to the market with a friend who plans to buy the same amount of the same apples and instead generate excess demand. The seller would find that he could drive up the price of his apples, since you and your friend will buy all the apples anyway and still don’t have enough afterwards.
This is the multiplication table of economics. It is absolutely essential that you as a prospective trader understand this simple connection, because it is the basis for the Forex market and the price determination on the stock exchanges in general. From here on, the level of complexity of the relationships increases exponentially.
The basic example with the apple market can also be applied to the foreign exchange market:
- Every time a particular currency is bought, there is a small amount of excess demand, which increases the price / rate.
- Likewise, selling currency leads to excess supply, which lowers the price / rate.
The impact of a single such shift is determined by the trading volume of the transaction – for example, weighty traders such as national banks can cause a serious imbalance if they change the volume of their national currency. On the other hand, smaller traders such as private traders can only influence the market balance individually to a small extent – but their large number in turn gives them greater, combined influence.
The philosophy of price balancing , based on supply and demand, is a key component in the functioning of forex trading and the stock exchange. All economic events that occur in the world are relevant to the market in only one way: to what extent they influence (possibly planned) supply and demand of an asset.
Going back to the apple market. if one of the two apple sellers has to leave the market due to bankruptcy, for example, they can expect apple prices to rise.