In the globalized world, the wealth of a nation is not only determined by business activities inside the country, but also abroad. Thus, the better it is the country's competitiveness, the better its economic performances will be; its currency's exchange rate will be more stable as well.

If we are talking about the structure of a country's economy, then there are internal and external sectors, in which external usually involves trades and transactions with other countries. In the globalized world, the wealth of a nation is not only determined by business activities inside the country, but also abroad. Thus, the better it is the country's competitiveness, the better its economic performances will be; its currency's exchange rate will be more stable as well. This is how balance of trade affects exchange rate.

Trade

 

Balance of Trade

Balance of trade, or trade balance, can easily be described as the difference between a certain country's exports and imports both in goods and services. If exports are bigger than imports, then the balance will be positive (trade surplus); while if imports are bigger than exports, then the balance will be negative (trade deficit). Trade balance is mainly derived from the domestic price of goods, taxes on imports/exports goods, and currency exchange rate.

Later, trade balance will be key figures in the country's balance of payment and forex reserves. Commonly, trade surplus is seen positively, while trade deficit is not. After all, bigger exports means more income for the country, while bigger imports means the country has to pay more to its trade partners. However, this is a mistake.

It is true that bigger surplus can lead to better economic growth, but you should remember that in Economics, there are nothing that is absolutely bad or absolutely good; each data brings its own impacts and externalities. At times when the country is in crisis and unable to fulfill its citizen's needs, then trade deficit is all right as it may incite productivity. On the other hand, trade surplus can also indicate trouble if it happens due to falling exports and worse imports, because it may indicate slumped domestic demands. In short, interpreting balance of trade cannot be separated from the current circumstances.

 

How Balance of Trade Affect Exchange Rate

Trade balance reports are usually published once a month. They are extremely vital in analyzing every country's economic situation, but not all of them can wield big impact in the forex market. The most influential one is undeniably US Trade Balance report, but depends on the pair, other countries' trade balance can be notable too.

Even so, for practical application in forex trading, most short-term traders only recall whether the actual figures are better or worse than estimated by economists and analysts. While longer-term traders like swing trader will consider the trade balance data by combining and comparing it with other data and its own periodical figures.

The general rule is if the figure is lower than expected, the currency most likely will go down. Otherwise if it is higher than expected, then the currency will probably be strengthened. However, trade balance can also give a chance to buy on the dips or sell on high. For instance, if EURUSD is currently in a bullish rally, then US trade balance figure went up, we can hope for EURUSD to slip lower; at that moment, look for a key support, and buy on the dips. It is possible because although quite high impact but balance of trade is not at the same level of interest rate announcement or Nonfarm Payrolls; often, prices returned to its path soon after withdrawing a step or two.

 

Beside of that, it should also be known that continuously disappointing trade balance may lead a country to devaluate its own currency, as is happening in Japan. This is because strong currency will lower a country's export competitiveness, while weak currency (up to a point, not extremely weak) tend to have wider advantages. There are many ways to devaluate a currency; so if a country's top officials has complained about how overtly strong is a currency, traders have to be on the lookout for scheduled and out-of-schedule activities. These measures including jawboning, interest rate cut, currency intervention, etc.