Crisis and Forex: Are They Connected?

The rise of Forex roughly coincided with the beginning of the economic crisis. Is it a coincidence? Perhaps not, as pondering the "ifs" is quite futile. However, it is very useful to reflect on how the crisis influences the currency market and identify, in this way, an approach that allows one to best exploit the situation. In truth, the crisis has represented an opportunity for many traders, not only for those who invest in currencies. A crisis is by definition, regardless of its economic-social-political nature, a moment of rupture, where balances risk shattering. It's a phase of change, where change means an evolution of both negative and positive signs.

There Are Crises and Then There Are Crises

To understand how a state of crisis can truly benefit a Forex trader, it is necessary to distinguish between the types of crises. From each, in fact, different reactions derive from decision-makers, which influence the relationships between currencies in an even more varied way. A crisis, for example, can be one of demand, like the current one. Regardless of its origin, which is purely financial, the current crisis involves the internal demand of individual states. The reasons are disparate, and depend on the specificity of each country, but it is undeniable: economies have found themselves in difficulty because consumption has fallen, businesses have not been able to generate profits, and unemployment has increased as a result. This situation still persists in much of the West. It is evident that if internal demand collapses, an economy must necessarily turn outward if it wants to survive. It must therefore go all-in on exports, at least temporarily, at least until the internal situation has improved. From here, the connection with the currency market is intuitive. An essential lever for increasing exports is the competitive devaluation of one's currency, which inevitably has a clear impact on Forex. It can be concluded, therefore, that crises of internal demand, like the current one, cause a race to the bottom for currencies, thus considerable instability. It is precisely in this instability, which quickly translates into volatility, that the trader can insert themselves.

The Issue of Monetary and Fiscal Policies

The reason why the crisis and Forex are closely linked can be traced back to the role of central banks and, in general, economic decision-makers. If an economy is in crisis, it means that it has not been able to find within itself, organically, the levers to solve certain problems, be they contingent or structural. Therefore, intervention from above becomes necessary to resolve the imbalances and put an end to the state of crisis. It is not surprising, then, that during periods of economic and financial difficulty, central banks are particularly active. The activism of central banks is a phenomenon that traders cannot ignore, since their firepower is such that it can clearly and permanently influence the currency market. Now, a central bank can adopt two approaches to respond to the crisis: with an expansive monetary policy or with a restrictive monetary policy. In the first case, the objective is to put money back into circulation, in order to restart - at least the official intent is this - economic activities, businesses, consumption and so on. The main levers are reference rates and monetary easing. In the first case, the central bank cuts the cost of money, while in the second it buys debt securities and, substantially, "creates money". What happens in the currency market? By the law of supply and demand, since the money supply in circulation increases, it depreciates (supply exceeds demand). In short, while internally there is an increase in inflation, externally there is a devaluation. This is what happened with the euro in recent years: the single currency has heavily devalued against the dollar. The central bank can also adopt a restrictive monetary policy. This is recommended when the economy is at risk of a bubble (financial, real estate, etc.) or when there is excessive inflation. Again using the lever of interest rates, which in this case rise, the money supply shrinks. By the same rule mentioned above, the currency appreciates compared to others, while internally prices fall. As can be easily seen, the intervention of a central bank is able to affect, not without difficulty, the value of currencies. Since central banks are particularly active during crises, it can be stated without fear of contradiction that there is a relationship - moreover a profound one - between crisis and Forex.

Crisis and Forex Trader: Opportunities for Traders

What can the trader do? There are two pieces of advice. First, it is good to give the right importance to fundamental analysis. It is generally mistreated in favor of technical analysis, but with a crisis underway and central banks very active, it is necessary to accurately analyze the economic context. Secondly, it is good to follow in detail not only what central banks do, but also what they think of doing - the statements of policymakers provide a clear orientation in this regard. It is also possible to adopt strategies that are not limited to survival, but also to exploitation. The opportunities arising from a state of crisis, for those who want to invest - indeed speculate - in the currency market are enormous. Here are three broad approaches. Taming volatility. The markets literally "go crazy" when central bank meetings approach, especially when there are urgent issues to be resolved on the table. The biggest bet for the trader is to intuit the content of the statements and anticipate the movements of investors. Remember Mario Draghi's famous "whatever it takes", that is, the declaration of intent with which the ECB ensured the euro's long life and foreshadowed the beginning of an ultra-expansive policy. Well, given the debt crisis in progress, this statement was not even that unexpected. The market was caught by surprise, however, except for those who had foreseen this turning point. Exploiting the diversity of the various monetary structures. The structure of central banks and governments suggests the ability of an economy to react to shocks, including monetary ones. For example, the Fed is much better equipped than the ECB to defend itself during a currency war, a race to the bottom. This means that, in the long run, the dollar will win, as it will be able to achieve its objectives. Traders who are aware of this are able to take advantage of periods of crisis and - consequently - of central bank interventionism. Identifying ongoing processes in the medium term. The crisis is made up of peaks and upturns. At least the current one, which in fact "boasts" a "U" shape (recession plus stagnation). One of the challenges for traders is to be able to understand in advance how individual phenomena will evolve. For example, about two years ago Europe experienced a real devastation of internal demand. At the same time, the United States was emerging from the crisis. This phase ended with a devaluation of the euro, which for some came unexpectedly. Not for others. Specifically, for those who had sensed that the only way Europe had to survive was to increase exports. The collapse of the eur-usd, therefore, was all in all predictable.