The foreign exchange markets may seem confusing for people that are new to this exciting world of trading, but the way these markets operate is actually fairly simple.

In short, countries that are doing well in economic terms see their currencies appreciate. On the other hand, economies that are doing poorly will usually experience falling currencies.

So, this year, we have seen the Australian dollar do very well, moving above parity against the US dollar. This is because the Australian economy is one of the best performing in the world.

By the same token, the US dollar has struggled as unemployment in the world's biggest economy came close to 10% and growth remained stagnant.

This year, in addition to the impact of local economies, there were two dominant themes - and both sprung from the global financial crisis that continues to affect markets.

Greenback gets hit

First, the US dollar has fallen sharply throughout 2010 as a result of weakness in the US economy.

The slowing US economy has caused the US Federal Reserve, the US version of our Reserve Bank of Australia, to keep interest rates extremely low and encourage them to pump more cash into the US economy.

With the US government clearly so concerned about the economy, investors have stayed away from the US dollar.

Also, the US government's quantitative easing programme, in which they print money to help growth, has caused the US dollar to lose value.

The decline of the euro

The other major driver of the currencies markets is 2010 was the crisis occurring over in Europe. For most of the last 18 months, investors have become increasingly concerned over the financial health of some of Europe's largest economies.

The initial concerns developed early in 2010 as worries about the fiscal position of Greece started to generate heat in the markets.  Once Greece was bailed out by the European governments, Ireland was the next country to start to look unsteady.

While Ireland has now been rescued, there remain concerns about even larger economies, including both Spain and Italy. If these two countries are also forced to the wall, then it is conceivable that we might even see the Euro zone split up.

So, from this perspective, there's little wonder why the Euro has been one of the worst performing currencies this year! If a number of your currencies governments are likely to go bust, and there's fears the currency itself might be about to bite the dust, then you might expect to see it lose value!

The Aussie strikes back

The other big story this year has been the Australian dollar.

The skyrocketing Aussie dollar has really grabbed the attention of currency traders after it passed the US$1 mark in November for the first time since it was floated in 1983.

The Australian dollar has been one of the best-performing currencies in recent months, jumping from US$0.80 in June to more than US$1.00 now ­ - that's an increase of more than 25% in less than six months!  ­

Australia's strong economic growth, and high demand for our commodities, has helped push the Australian dollar so high in 2010.

Japanese yen strengthens

One of the stranger occurrences in 2010 has been the strength of the yen.

Despite Japan struggling with slow economic growth, an ageing population and very low interest rates, the yen has been one of the better performing currencies.

Why is this? Again, the Japanese yen is performing for much the same reason that gold is going well this year: investors are looking for an alternative to the US dollar.

The Japanese yen has long been one of the world's most important currencies, and with the US dollar struggling, investors have naturally turned to the 'number two' currency, the yen.

What can we learn from this?

Currencies will usually go up or down depending on how well their economies are doing.

However, it is important to remember that markets are smart and they always try to work out what is going to happen in the future. This is how forex traders should also look at the market.

If you think the US economy is going to improve next year then you might think about buying US dollars. If you think we will see more problems in Europe then you might consider selling the Euro.  

With forex trading you literally have a world of opportunities at your fingertips!