Economic recessions are inevitable. It’s just a matter of how, not when, they’ll happen. For traders who trade in currencies, The next question to ask is, is the Forex market in a recession-proof state? The answer is no. It demands that forex traders react. The focus should be given to the kind of recession is at play in order to make the best forecast possible regarding how long and serious the recession could be.
If you already have positions in the market, then you might want to safeguard the positions in case of a recession. If you’re attempting to enter the market in a new way, you’ll need to identify the most profitable opportunities for trading forex. They could be buy-and-hold techniques or even day trading forex.
There is no one who wants the prospect of a downturn to emerge. However, forex traders who plan for a slowdown in the economy could turn the underlying shifts in a country’s economy into trading opportunities. This description of the best ways to trade in forex during a recession outlines ways to capitalize on the turmoil that comes with slowing economic growth.
What is a recession?
A recession is an economic downturn and industrial activity during which the country’s gross national product (GDP) shrinks over two consecutive quarters. The GDP figure is comprised of information supplied by the service and manufacturing industries of our economy. It is possible that both are devalued or both fall in such a way that brings the total amount to a negative number.
Other information points may give an insight into the health of an economy. They can also add some color to allow traders to profit from positions. Additional numbers to keep an eye on are real earnings, inflation, the level of employment, industrial output, and wholesale-retail sales. When these indicators change, the demand for a nation’s currency is likely to increase and decrease.
A Historical Perspective on Recessions
Between 2010 and 2020 was, generally, in the sense of prosperity for the economy over the long run. It was characterized by a low rate of inflation and interest rates remaining low because of the central banks’ pumping money at a low cost into the markets for financial services following the Great Recession, which occurred between December 2007 and June 2009. This was the longest period of contraction that has occurred since the Great Depression of 1929–38.
The tools that government agencies and central banks utilize to control the economy may be a bit sluggish and unwieldy. In the same way, they may overestimate and lead to an economy emerging from recession, only to be pushed into an era of rapid growth. That makes anticipating the length and severity of a recession an arduous task, which causes higher volatility in prices because analysts have widely different opinions on the potential results.
Forex Markets During A Recession
They don’t respond the same way as other asset classes in the event of a recession. For instance, stock markets tend to decline in value in times of economic downturn, but currencies function more as an engine of the economic system than an element of it. One thing that is likely to be noticed is the currencies of countries that are stronger increasing in value compared to the currencies of countries that are experiencing a more severe recession.
The reason why a currency of one country will be used in a greater or less degree is due to economic fundamentals. One example would be the currencies of the major exporting nations like Japan. In times of global economic downturn, Japanese auto manufacturers and tech companies can anticipate the demand for their products to drop. Because a significant portion of demand is generated by global trading partners. Any decrease in the demand for Japanese products will lead to lower Japanese yen being purchased on the markets for currency.
USDJPY – Daily Price Chart – 2018 – 2022
Source: IG
A recession could also be short-term and localized and not global in its nature. It could be because of the outcome of a political event in the short term, like the Brexit referendum which resulted in a surprising outcome that stunned the investors. This resulted in a temporary decrease in confidence and production, which led to the pound’s value plummeting.
GBPUSD – Weekly Price Chart – 2010 – 2022
Source: IG
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Recessions are a subject that forex traders must be prepared for with open eyes. Making preparations for one by using fundamental analysis as well as technological analysis could result in profitable trading of both short and long-term movements in currency prices.
Currencies that perform badly during a recession
The process of trading forex successfully in a downturn starts by conducting research and keeping track of important data points like interest rates.
If an economy is in decline, it will likely receive assistance from the central bank and the government. A highly efficient and swiftly-acting tool for policy is interest rates. The majority of central banks adjust them regularly—usually occurring about once per month.
The reduction in interest rates could help increase the productivity of an economy because borrowing is less expensive. Corporates and consumers alike benefit from the money flow. A vicious circle of increased production and spending could get the economy moving towards the next phase of expansion.
Lower interest rates could also lead to lower returns for savers. If another country is, at the same time, not in the midst of a recession or, at the very least, outperforming its peers in this regard, then the interest levels in that particular country could be expected to stay at a higher level. The sale of one currency as well as purchasing another lets savers switch to a different currency that provides better returns and can affect the value of their respective currencies.
A currency’s value is reduced through the use of interest rate policies, which can help boost exports from a country that is struggling. The products of the country are comparatively less expensive on the international market, which is another way for it to start to rebuild. This is why central banks view reducing interest rates as a dual strategy to get the economy out of recession and stimulate growth. This is why the risk of a recession can result in projections for interest rates being cut and drastic changes in the prices of currencies.
Currencies that perform well during a recession
The currencies of nations with strong economies are likely to increase in value during a global downturn. It is possible for interest rates to stay at higher levels because the central bank is equally concerned about the possibility that comes with the risk of inflation as they are concerned about the possibility of a decline in economic growth.
Currencies, recessions, and the fear factor.
It is essential to think about the fear factor along with the economic fundamentals. In times of global recession, the demand for US dollars as well as the Swiss franc is likely to rise because of their status as safe-haven assets. This is due to the fact that if prolonged recessions result in the collapse of the financial system of the world and banks face the risk of going into default in the event of a default, you’re better off keeping the currency most likely to not get stuck in a panic against the bank.
A drop in the mood due to a recession could result in large corporations cutting back on plans for expansion. If multinationals based in the US cut back on ambitious overseas ventures, this will affect the price of currency. As the amount of investment in emerging markets decreases and so does consumers’ demand for currency of these countries, since there is no longer any need for the currency of the developing nation to be purchased.
FOREX MARKETS AND LOCALISED AND GLOBAL RECESSIONS
Price movements for currencies may be quite different in their nature based on the kind of recession that is currently taking place. When there is a global recession, it is possible to feel that one particular currency is the strongest of the bunch, or that one is especially weak. There are likely to be some currency fluctuations, but they are susceptible to being less drastic when one country is suffering from a localised recession.
Between 2000 and 2002, The Argentine peso (ARP) was under severe pressure because it had been untruly pegged against the US dollar, leading to a bank crisis. In the case of that time, there was a panic in the peso that caused it to decline in value from parity with USD in the month of October 2001 to 3.51 pesos for the dollar a year later. In the context of the global economy being fairly stable, the eyes of speculators from around the world were upon that USDARP currency pair. In addition, the large flows of cash caused the price to fall.
How to Trade Forex During a Recession?
The trading of forex in a downturn is as much about the way you trade as the way that you trade. There are numerous Forex strategies that can assist you, but we have provided some basic guidelines to maximize your return.
INVESTMENT TIMELINES
A clear plan of action will always be an excellent thing, however, it is essential when you are running forex trading strategies during an economic downturn. Timelines for investing must be taken into consideration as recessions can last for a long time. On the other hand, day traders may be able to make money from the erratic price movements of intraday prices.
It is therefore crucial to “run your winners” and remain in trades that are profitable. Every trade won’t turn an income, but successful trading is about cutting out the losing ones in time and maximizing the returns of profitable ones.
SELL SHORT & BUY LONG
Each trade in forex is comprised of two components. The process involves simultaneously purchasing one currency while selling another.
Selecting the best exchange rate can lead to the most profit as you gain on both sides of the transaction. In the first quarter of 2022, investors who had an opinion that it was likely that the European Central Bank was unlikely to raise interest rates may have traded short on EUR. Reliable brokers offer a variety of EUR-based currency pairs. IG provides EURUSD, EURGBP, EURJPY, EURCHF, and EURCAD.
EURUSD – Daily Price Chart – 2021 – 2022
Source: IG
The best option in terms of practicality would be to invest in EURUSD since it’s the most traded currency pair around the globe and spreads on trading are tense. But, there is another currency pair that could give better returns.
In particular, between the 1st of June and the 31st May 2022, prices of EURUSD changed by 5.64 percent, however, over the same period of time, EURCAD recorded a 6.60 percentage price fluctuation. It is because the fact that CAD is considered to be a better investment over both the euro and US dollar.
EURCAD – Daily Price Chart – 2021 – 2022
Source: IG
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MANAGE RISK
Price volatility is likely to rise during a recession. In a state of panic, investors could make unpredictable decisions, and uncertainty regarding how effective policies could be leads to investors having extremely different opinions on what prices are expected to be.
The trading of forex during a recession is therefore a good time to scale down on the size of the position and leverage. The result is price swings that may be larger in terms of percentage points, but lower to cash. Smoothing out returns and establishing the capacity to stay in the market is an integral part of being an responsible investor and achieving regular long-term, consistent returns.
SIGNALS TO LOOK FOR
Trends in Forex may last for months or years, but don’t anticipate each trade being profitable right from the beginning. The process of averaging into positions with the VWAP method lets you slowly build up an investment rather than go all-in and risk being kicked out of the deal before it actually gets underway. The use of range trading strategies could assist you in entering transactions when the currency pair has reached the end of its shorter-term range of prices.
FINAL THOUGHTS
Forex trading during a recession requires taking into consideration the distinct features of a slowdown in the economy. It is the first thing to determine whether the recession is localized as well as part of a global trend which will give clues to the nature of the subsequent price fluctuations. It’s then a matter of waiting for the expected shifts in the cost of an exchange rate pair to change to reflect the state of the economies that are underlying.
The basic rules of forex trading are the same, however, while selecting the most suitable option for your plan is vital, it is beneficial by choosing one that has numerous options to trade. This short list of reputable brokers comprises those that have been evaluated through the AskTraders team and have verified that they’re safe and provide an array of markets for forex to assist traders in making the most out of the trading opportunities. If you’re a novice to trading or an experienced one, They provide a great way to trade forex in times of recession.
