How To Trade The Economic News In Volatile Markets
We are currently living through a time of geopolitical and economic turbulence, as the world deals with multiple challenges. A global economy only just emerging from the battering of the Covid pandemic is under further strain from the ongoing war in Ukraine and instability in African regions.
Demand for commodities such as oil and gas has increased as the world bounces back from the pandemic, while the Russian invasion of Ukraine reduced availability. This led to a sharp hike in prices, with domestic users and businesses hit with higher fuel bills. The price of other commodities such as wheat, dairy and cooking oil has also spiked.
The knock on effect has sent inflation soaring to unprecedented levels, accompanied by a series of interest rises. In the UK there has been a period of political instability, with four Prime Ministers in the last five years and frequent changes of Chancellor. The coming year still holds uncertainty as the country is likely to face a general election.
The frequency of natural disasters and the consequences of climate change are also affecting the economic and geopolitical stability of the world more strongly than ever before. Drought is affecting food production in some areas, with wildfires becoming more widespread and fierce in hotter climates.
All this naturally has an impact on the financial markets, and this leads to greater volatility. For forex traders, it is important to understand what volatility is, what causes it, and how to navigate trading during volatile times.
What does volatility mean in relation to forex markets?
In forex, volatility refers to the amount the price of a currency fluctuates within a time period. When the price of a currency deviates sharply from the average, either upwards or downwards, it is described as high volatility. Times of milder fluctuations are described as low volatility.
The forex market is known for high levels of volatility. This is why it offers traders good opportunities to make profitable trades, because there are frequent windows to buy currency at lower price and sell at a higher price, or vice versa.
However, high volatility also carries a high level of risk, so it is important to be able to read market movements and make well informed decisions when selecting position size and stop loss level.
While it is never possible to predict exactly which way the market will move, learning how to manage risk and make decisions based on probability will help a trader to avoid some of the worst pitfalls.
Some currency pairs are more volatile than others. The Japanese Yen and the Swiss Franc are regarded as ‘safe haven’ currencies, along with the US dollar. This means that they tend to hold their value even during periods of volatility, so they can help to mitigate some of the risk of trading in turbulent times.
The Japanese Yen is particularly stable because the government keeps the interest rate deliberately near zero levels for complex reasons. The Swiss franc is also highly stable thanks to the country’s gold wealth and a strong central bank and financial system.
The US is the world’s largest economy, at the forefront of technological developments and rich in commodities. The US dollar is also the world’s reserve currency, meaning that the majority of foreign bank reserves are held in the USD. Therefore there will always be a strong demand for this currency.
What are the causes of forex market volatility?
The best way to understand the causes of volatility in the forex markets is to follow relevant global events and the economic news. The market is very sensitive to geopolitical factors, which means the interaction between geography, politics and economics at a national and global level.
Follow current affairs with a particular focus on military invasion, civil unrest and uprisings, general elections, and any other sign of instability including natural disasters and pandemics. This can cause investors to withdraw from a currency and sell off existing assets, triggering a period of volatility.
Nations will also sometimes engage in trade wars, setting hostile policies to disadvantage a rival country or region and boost their own prospects. This can occur at any time throughout the world. When they involve major economies such as the US, China, and Europe, the knock on effect on currency prices can be particularly marked.
Interest rates are also a major influence on currency price. The monetary policies of central banks, such as the US Federal Reserve, the European Central Bank, and the Bank of England regulate the amount of money circulating in the economy.
When the central banks raise interest rates, as most have done recently to tackle rising inflation, it makes it more costly to invest in the country, and investors may transfer their money to bank accounts, or sell assets to avoid capital gains tax.
On the other hand, the financial sector, including mortgage lenders, banks, and insurance companies, tend to benefit because they are able to charge more for their services.
When interest rates are lowered, consumers have more spending power, which in turn benefits retailers and the wider economy. It is also cheaper to borrow money, increasing consumer confidence, but conversely this may lead to a rise in inflation as demand for goods and services increases. In response, interest rates may be lowered again.
There are various other economic factors that have an impact on the forex markets to a greater or lesser extent. Some of them are specific to regions, countries, or currencies, so it pays to do some in depth research on the currency pairs you want to trade.
Use the economic calendar to keep track of the significant data releases and events that are relevant to your trading strategy. As you gain experience, you will be able to customise the calendar so that you have the most important information to hand.
Major economies are particularly sensitive to unemployment rates because this is a bellwether of how well the economy is doing—low unemployment means it’s doing well, and a high unemployment rate means that it is struggling and the population will have less money to spend.
The Government will be under more pressure to borrow and spend on social security, and tax revenues will be reduced. Higher unemployment than expected will trigger volatility in the forex markets, as traders look to sell off currencies that they expect to fall in value. Higher than expected rates of employment will drive up demand for the currency.
Other indicators to look out for include the following: inflation, the gross domestic product (GDP), the consumer price index (CPI) and business sentiment surveys.
Market sentiment also has an influence on price movement. The term refers to the prevailing mood of traders and investors about which way the market is moving, and this in turn can drive prices up or down in value.
Finally, markets tend to move in a cyclical fashion, regardless of outside influences. If prices have been rising steadily for some time, at some point they will peak as investors sell at a profit. This naturally pushes prices down for a time before they begin to rise again.
How to trade in a volatile market
A highly volatile market suits short term traders, because the market swings create more opportunities for making high profits in a short timeframe. However, there is also the potential for damaging losses to occur, so it’s essential to know your risk tolerance and have a strong risk management strategy in place before making live trades.
It’s not possible for even the most experienced and knowledgeable trader to predict 100% which way the markets will move, only to make decisions based on research and technical analysis. Common technical tools used to measure price changes include Bollinger bands, Average True Range (ATR) and the Relative Strength Index.
As previously mentioned, some currency pairs are more volatile than others, and following the economic news will put you in a much stronger position to anticipate market movements. Highly volatile markets are not a bad thing in forex; after all price movement is how profits are made.
The most volatile currency pairs tend to be the Australian dollar and the Japanese yen, the New Zealand dollar and the Japanese yen, the Australian dollar and the US dollar, the Canadian dollar and the Japanese yen, and the Australian dollar and the British pound. These pairs are closely related to commodity prices such as oil, timber, and minerals.
The least volatile currency pairs tend to be from the largest and most stable economies, and include the Euro and the British pound, the Suro and the US dollar, the Swiss franc and the US dollar.
As ever, keeping your emotions in check and being strictly objective in all your trading decisions will help you to avoid taking unnecessary risks. Make sure you have read up on the psychology of forex trading and are aware of the temptations of greed, and the dangers of being too cautious or overconfident.
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