After contracting by 0.3% in the second quarter of 2022, a further contraction between July and September has sent the UK economy into a technical re
After contracting by 0.3% in the second quarter of 2022, a further contraction between July and September has sent the UK economy into a technical recession.
What’s more, the Bank of England (BoE) has forecast that this could last for five consecutive quarters through the end of 2023, which would be the longest recession in UK history.
While this is an obvious issue for households and businesses, it also creates significant challenges for investors, who have to review their portfolios and understand how certain assets perform during periods of recession.
Forex is one such asset, and in this post, we’ll ask how you can look to trade in this market successfully during a recession.
What’s a Recession and How does the FX Market Typically Respond?
A recession is a technical term to describe two consecutive quarters of economic contraction, and while the word is often used to describe periods of austerity or reduced growth, such applications are generally inaccurate.
This creates a ripple effect throughout the economy, as each financial market reacts differently to periods of recession and quantitative easing techniques manipulate the macroeconomic factors that directly impact forex.
Because of this, the FX market tends not to react to a recession in the same way as other asset groups. For example, while stocks and equities tend to see their value depreciate during a recession, currencies are speculative and highly liquid assets that will fluctuate according to the relative strength of the underlying economy and the damage wrought by the recession.
This is because currencies are more of a lubricant of the macroeconomy than a tangible component, which means that while some currencies may see their value decline, others will appreciate markedly over time.
To provide some context, major exporting nations like Japan and Australia typically see their currency values decline during a recession, as demand for their goods falls and lower quantities of Japanese yen are purchased throughout the currency markets.
Conversely, strong currencies or those that are underpinned by a more robust economy tend to perform better during a recession, creating additional opportunities for forex traders to profit.
How to Trade Forex Successfully in the Current Economic Climate
Given this and the speculative nature of forex trading (currencies can be bought, sold and exchanged without the need to own the underlying financial instrument), it’s little wonder that the FX market is popular during a recession.
But what steps can you take to trade forex successfully in such conditions? Let’s find out!
#1. Understand the Impact of Inflation and Interest Rates
Currency prices are impacted in real-time by a wide range of macroeconomic factors, including inflation and interest rates.
This is especially important in the current economic climate, as we’re in the grip of an inflationary recession where the CPI Index was running at 11.1% in November. While it’s thought that inflation may have now peaked in the UK, it remains well beyond the 2% set by the BoE.
Inflation of this nature tends to diminish the purchasing power of an afflicted currency, making it less valuable over time. So, economies with the highest rates of inflation see currency devaluation at a much faster pace, making currencies like the pound (GBP) less viable in the current climate.
In order to combat inflation and incentivise saving over spending, the BoE has also carried out a number of base interest rate hikes since December 2021.
Interestingly, this increases the value of the associated currency and may see a rise in demand from overseas, boosting capital inflows and interest from foreign investors.
Understanding this is key to trading successfully during a recession, especially when choosing viable currency pairings and adjusting your risk portfolio.
#2. Readjust and Define Your Goals
Ensuring that you have clearly defined goals as a forex trader is also important, but this is arguably even more crucial during a recession.
In fact, you may have to readjust and further define your objective when the economy enters a recession, in order to account for the changing conditions and shifting macroeconomic factors.
Most importantly, you may need to adjust your trading strategy and appetite for risk, perhaps eschewing short-term methods such as scalping in favour of long-term strategies such as position or swing trading.
You may also want to reduce your leverage in order to minimise losses as the economy contracts, while potentially seeking out new opportunities in the form of arbitrage trading.
This is a technique that enables you to profit from temporary market inefficiencies and pricing errors by brokers, which tend to increase in volume during periods of economic or market volatility.
#3. Review Your Entry and Exit Points
Another universal aspect of forex trading is the establishment of entry and exit points, which can be managed manually or by using automated risk management tools.
You can deploy automated forex signals to identify entry point opportunities, for example, while leveraging so-called “stop losses” to automatically close certain positions once they’ve incurred a predetermined level of loss.
Your typical entry and exit points may change depending on the wider market conditions, particularly in instances where your strategies evolve and you begin to operate in different timeframes.
The level at which you automatically close positions may also change during a recession, especially as you look to conserve your capital and adopt a more risk-averse approach over time.
We’d recommend that you review your strategic entry and exit points as soon as possible once a recession begins, as this helps to prepare you for new trading conditions while minimising exposure and the risk of loss.
Related Articles
news.google.com