Every sovereign country has it’s own central bank. The US it’s called the Federal Reserve Bank. In Canada it’s simply called the Bank of Canada. Then there is one for all of Europe called the European Central Bank. It’s also known as the ECB.
It is important to understand the mission of central banks in developing your forex trading currency strategies. They affect monetary policy which in turn affects their currency valuations and exchange rates.
The mission of central banks is simple. It is to establish monetary policy to keep their economy stable and growing. It is also their mandate to keep their currency stable and to manage inflation.
Here are some of the ways the fulfill their mission. One way that is not done very often is actually currency trading. They usually don’t buy and sell their currencies to manage their policies. It can interfere with the free market system and so they don’t do it unless there is a really unique reason.
Trading is the extreme side of what they do. On the other spectrum there is making announcements. Sometimes when a central banker even hints at potential policy changes or rate changes, it can be enough to affect the market. It can be a self-fulfilling prophecy of sorts.
Sometimes they do have to step in and do something. Most of the time it’s through interest rate hikes or cuts. Even just a quarter point cut or hike can do wonders for affecting the forex market. A quarter point is basically .25% on the interest rate.
Although central banks are usually taken as a good source to know the state and health of an economy, many economists point out that, historically, they haven’t really been that accurate. So whatever the US Federal Reserve says, many people take it with a grain of salt.
The only reason you don’t need to know about central banks is if you do forex arbitrage trading as your main strategy. But if you do, you still need to understand when a central bank announcement or policy might invoke volatility in the currency markets that might provide an arbitrage opportunity.