Effects of COVID-19 on forex trading ?
“If you want to know the size of your wealth then you need to count the people who are below yourself.”
True lines, if you want to be on the top then you have to keep all the other under your foot so that you can stay beyond their reach. This how mostly or I must say every major and minor economy in this world works and when this whole system is disturbed, there is a need for a system update and in a process of this system update everything pauses , except the update itself. What are these updates in the Economic System? The most relevant answer is War, PANDEMIC, Recession, Depression or the global emergencies.
Now, let’s talk about the current scenario of COVID-19 Pandemic. There are many questions bothering our notion when we speak or think about this brutal disease, like:
Q1: Why did this happen?
Q2: Who will get benefitted out of it?
Q3: What will be the advantages of this Pandemic situation?
Q4: How will this impact the Big Business Houses? Who will rule the Economic Pipeline after this gets over?
Q5: Is it a scope goat for many sins done by the Capitalist? (Bank frauds, Insolvencies, Mergers and Acquit ions)
Q6: How is everything going to rebound?
Q7: Last but not the least, why should we analyze all these factors and how we will get benefitted from the same?
So, first of all let’s keep aside every conspiracy theory related to this Pandemic. Why am I saying this? It’s because none of the supreme power wants to lose their people keeping in account the lines quoted by John Locke”- POWER=WEALTH=CONTROL, “SO POWER COMES FROM PEOPLE”
Now it’s the time to discuss a common logic behind COVID-19 , the impact it’s having on the world economy and how we will get benefitted out of it, Please read the pointers as below:-
1) Would you prefer to buy luxurious items like expensive cars, perfumes, exotic vacations, etc after the lock down? Probably your answer will be NO and if answer is YES, then congratulation you are the child of either a Politician or a Renowned Business Magnet or probably you are the client of Carlos & Company. Jokes apart, it’s good that all the disposable income shall then be spent on the basic necessities likehealthcare, groceries (especially FMCG and agro- based products), insurance and investments.
All the above options will boost the economic activities globally and as a result of which all the centralized banks will infuse huge money in their economies which can further increase the import and export, as a fruitful return, the Forex market will get healthy momentum. We all know that all major economies are aware of the currency crunch post lock down bound to happen globally as currencies may starts to devaluate, to hedge this risk they are ready with QE and helicopter money to stabilize the currency market. Also it is the time to gain an upper-edge by acquiring new ventures and proceeding for new mergers as almost all company’s shares globally shall be trading at very attractive prices. Mergers and Acquit ions require and initiate large chunks of money to flow in the market.
So, our main focus will be on Forex markets, Insurance Sector, Argo-based Businesses like Fertilizers, Seed companies and other ancillaries, Food Processing Businesses, Investment Industries and Banking along with the bond market (especially corporate bonds).
Why all these industries?
It’s because due to this economic buffer, almost every major rating agency has downgraded the ratings for developed and developing economies. This will impact the particular country’s currency and as result most of the currencies starts to devaluate. So, to control this devaluation, major currencies like Dollar, Euro, GBP will increase their supply through Quantitative Easing.
Risk Aversion is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens that may affect market conditions. This behavior is caused when risk adverse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty.
In the context of the foreign exchange market, traders liquidate their positions in various currencies to take up positions in safe-haven currencies, such as the US dollar. Sometimes, the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics. An example would be the financial crisis of 2008. The value of equities across the world fell while the US dollar strengthened. This happened despite the strong focus of the crisis in the US.
Important Concepts to keep in mind
Currency carry trade refers to the act of borrowing one currency that has a low interest rate in order to purchase another with a higher interest rate. A large difference in rates can be highly profitable for the trader, especially if high leverage is used. However, with all levered investments this is a double edged sword, and large exchange rate price fluctuations can suddenly swing trades into huge losses.
That’s the main reason why we will be focusing more on the Forex activities along with indices and risk heaven instruments.
Major Financial Instruments on which we need to keep keen eyes are as:-
A spot transaction is a two-day delivery transaction (except in the case of trades between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract, and interest is not included in the agreed-upon transaction. Spot trading is one of the most common types of Forex trading. Often, a forex broker will charge a small fee to the client to roll-over the expiring transaction into a new identical transaction for a continuation of the trade. This roll-over fee is known as the “swap” fee.
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.
Non-deliverable forward (NDF)
Forex banks, ECNs, and prime brokers offer NDF contracts, which are derivatives that have no real deliverability. NDFs are popular for currencies with restrictions such as the Argentinean Peso. In fact, a Forex hedger can only hedge such risks with NDFs, as currencies such as the Argentinean Peso cannot be traded on open markets like major currencies.
The most common type of forward transaction is the foreign exchange swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. A deposit is often required in order to hold the position open until the transaction is completed.
Futures are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
Currency futures contracts are contracts specifying a standard volume of a particular currency to be exchanged on a specific settlement date. Thus the currency futures contracts are similar to forward contracts in terms of their obligation, but differ from forward contracts in the way they are traded. In addition, Futures are daily settled removing credit risk that exists in Forwards. They are commonly used by MNCs to hedge their currency positions. In addition they are traded by speculators who hope to capitalize on their expectations of exchange rate movements.
A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.
Economic factors to include in our analysis while making any trading decision:-
Economic factors include: (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators.
Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government’s central bank influences the supply and “cost” of money, which is reflected by the level of interest rates).
Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country’s currency.
Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country’s currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation’s economy. For example, trade deficits may have a negative impact on a nation’s currency.
Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rise because of the expectations that the central bank will raise short-term interest rates to combat rising inflation.
Economic growth and health reports such as GDP, employment levels, retail sales, capacity utilization and others, give all the feasible detail about the levels of a country’s economic growth and health. Generally, the more healthy and robust a country’s economy, the better will its currency perform, and the more in-demand it shall be.
Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency, whose effects are more prominent if the increase is in the traded sector.
How we deal with all these psychological factors?
Market psychology and trader’s perceptions influence the foreign exchange market in a variety of ways:-
Flights to Quality: Unsettling international events can lead to a “flight-to-quality”, a type of capital flight whereby investors move their assets to a perceived “safe haven”. There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The US dollar, Swiss franc and Gold have been traditional safe havens during times of political or economic uncertainty.
Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Currency’s Cycle Analysis looks at longer-term price trends that may rise from economic or political trends.
“Buy the rumor, sell the fact”: This market strategy can be applied to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being “oversold” or “overbought”. To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.
Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself, becomes important to market psychology and may have an immediate impact on short-term market moves. “What to watch” can change over the time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.
Ping us to know how to trade in covid19.
by the author.