| Updated: September 12, 2025Long-term factors driving the foreign exchange market: capital and trade flows
This lesson will cover the following
- General thoughts on forex market drivers
- Capital flows
Before following a trading strategy, you should have a deeper understanding of the factors that drive the foreign exchange market. There are plenty of opinions regarding the most reliable strategies – some traders rely on fundamental analysis, while others rely solely on technical indicators. However, the best strategies probably involve both. There are cases when technical patterns fail because of the release of major economic reports or announcements by central bank officials. There are also cases where significant movement occurs because of a price action set-up, even though no economic indicators were released. Therefore, traders who rely on technical analysis should be aware of the release of major economic data or other fundamental events, while fundamental traders need to be aware of the key technical levels that the wider market may take into consideration.
Fundamental traders must constantly monitor events and news that may have a serious impact on the political, economic and social environment. We devote an entire chapter to the most important fundamental indicators in our forex trading guide. Now let us look at some of the major factors that determine the movement of currency pairs.
Capital and trade flows
Capital flows
Capital and trade flows comprise the balance of payments of any country, an indicator closely related to demand for a given currency over a particular period. A balance of payments amounting to zero usually means that the currency will maintain its present valuation. If a country’s balance of payments is positive, this indicates that capital is entering the economy faster than it is leaving; therefore, the value of the country’s currency should increase.
- Trade Forex
- Trade Crypto
- Trade Stocks
- Regulation: NFA
- Leverage: Day Margin
- Min Deposit: $100
Capital flow, on the other hand, indicates the net amount of a given currency being purchased or sold as a result of capital investments. If a nation’s capital flow balance is positive, this means that foreign inflows of physical or portfolio investments in the country surpass outflows from the country. If a nation’s capital flow balance is negative, this means that foreign investors hold fewer physical or portfolio investments than domestic investors.
Flows of physical investments include foreign direct investments made by business entities in sectors such as manufacturing, real estate or local corporate acquisitions. These investments require that foreign business entities purchase the local currency and sell the foreign currency, which triggers movement in the foreign exchange market. These flows reflect actual investment activity and vary with the financial state and economic growth prospects of a given country. Changes in domestic laws intended to spur foreign investment also stimulate physical flows.
Flows of portfolio investments include capital inflows and outflows in stock and fixed-income markets. A surge in the stock market in any region of the globe attracts investors from elsewhere because of the rapid advances in technology that facilitate the transfer of capital. This has led to a significant correlation between the stock market in a given country and its own currency. When the stock market is in an uptrend, investments in the local currency increase, as many individuals and companies are unwilling to miss the opportunity to profit. If the stock market is plummeting, local investors will begin to sell off shares of public companies and move their capital to more attractive opportunities abroad.
Fixed-income markets also correlate with the foreign exchange market. Investments in fixed-income assets rise markedly during periods of global economic or political uncertainty, as these assets are considered inherently safe. Countries offering the most attractive fixed-income opportunities usually attract investments from abroad, which require the purchase of the respective local currency.
Short-term and long-term yields of government bonds worldwide serve as gauges of capital flows into fixed-income assets. Traders usually pay close attention to the spread differentials between the yield on 10-year US government bonds and the yield on government bonds of other countries. International investors generally place their capital in countries that offer assets with the highest yields. If Canadian assets, for example, offer some of the highest yields, this would attract more investment in Canadian financial instruments and would also increase the value of the Canadian dollar.
For investors who wish to follow fund flows over the short term, an appropriate gauge is the spread between two-year government bonds of the respective countries. Federal funds futures are also a useful gauge of the movement of US funds, as they reflect expectations regarding future Federal Reserve interest-rate policy. In the eurozone, futures on Euribor (Euro Interbank Offered Rate) reflect expectations regarding future European Central Bank rate policy.