Updated on January 25, 2023
Recession rumours have plagued most of 2022, with many placing the possible timeline somewhere around late 2023. This information has many investors searching for different avenues to protect their investments from being wiped out. Consequently, many have turned to commodities, large-cap stocks, and even cash! With this article, we explore forex trading and answer the question: Is forex recession-proof?
The foreign exchange market, also commonly known as forex or FX, is basically a decentralized market where currencies are traded. Forex trading involves the exchange of one currency for another and profiting from the disparities in currency values. For instance, supposing a trader believes the value of the US dollar will increase against the Euro, they can purchase dollars with Euros with the hope that they will later sell at a higher price.
With a daily turnover of roughly $5 trillion, the forex market is the biggest financial market. Forex trading is conducted through a bank or a licensed broker. Many investors believe that the forex market is recession-proof and can guarantee a steady flow of income even during the worst economic times.
Although some investors believe the forex market can guarantee steady returns during an economic meltdown, a brief look at the market’s historical performance paints a different picture.
In the 2008 financial crisis, the forex market was significantly impacted. As the crisis spread globally, investors started pulling their money out of the market in droves. This caused a drastic drop in the value of many currencies, especially those of weak and highly indebted economies.
Another recession that had a notable effect on the FX market was the Asian financial crisis of 1997. The crisis was the result of the devaluation of the Thai Baht. This culminated in a sharp decline in the value of many Asian currencies. Consequently, there was a spillover effect on other markets, including stock and bond markets.
Historical records show that investors turn to strong currencies such as the US dollar and the Japanese Yen during recessions. Consequently, the increased demand drives up these currencies’ value while further depreciating developing nations’ currencies.
Another factor to consider when looking at the historical performance of the forex market during recessions is interest rates. Central banks usually lower interest rates to stimulate economic growth. However, this also leads to a depreciation in the value of their currencies. This makes it a less attractive alternative for foreign investors.
Factors that make the forex market recession proof
Most traders consider the forex market one of the world’s most resilient and recession-proof markets. For example, despite the 2008 global meltdown, the forex market largely continued to function and even managed to provide a few smart investors with some gains. Let’s explore what actually contributes to the forex market’s resilience.
FX market size
The size and liquidity of the forex market act as a buffer. This protects it from the worst effects of major economic crises. With an average daily trading volume of roughly over $5 million. The forex market is arguably the world’s largest and most liquid financial market. In simple terms, sellers can easily find a buyer for any currency. The market operates 24 hours a day, 5 days a week and thereby facilitating trade.
Diversification & Decentralisation
The forex market is largely decentralised and, therefore, not controlled by any central government authority or institution. This makes the market less susceptible to other markets’ economic and political risks. The decentralisation factor allows for a wider breadth of diverse opportunities traders can take advantage of.
The forex market involves the trade of many different currency pairs, which offers traders the chance to diversify their portfolios. Therefore, a trader can offset the risk level caused by certain currencies in his portfolio by investing in some ‘safer’ options.
Although many traders consider the forex market a safe haven during times of recession, it is essential to remember that the market is not entirely immune to the effects of a recession, and there are still many risks attached to trading forex during a recession.
One of the main risks associated with trading forex during a recession is that as countries experience a decline in economic growth, they experience a decline in the value of their currency. This can be truly challenging for traders who are holding positions in those currencies because they inevitably experience significant losses.
In times of recession, traders tend to become risk-averse and are more likely to close their positions quickly. This alone increases market volatility. Consequently, the increased market volatility makes it challenging for traders to accurately predict price shifts in the market.
Another key consideration to keep in mind while trading forex during a recession is the fact that global events and geopolitical tensions heavily influence the FX market. During times of recession, these forces are more keenly felt in the market. As a result, traders find it more challenging to make informed decisions and are exposed to higher chances of loss.
Trading Forex in a Recession
In order to trade forex successfully during a recession, you must have a good grasp on the forces that influence currency pair fluctuations. For instance, because the USD is the world’s default funding currency, the rest of the world must have enough reserves of this currency when attempting to deleverage. This makes holding this currency a potentially great recessionary hedge.
Another way to successfully trade forex during a recession is to consider the effect of certain economies on others. For instance, China is an important market for Australia’s vast commodity resources. This means economic troubles in China could negatively impact AUD.
Lastly, focusing on currency pairs traditionally known as safe havens, such as JPY and CHF, might be a strategy worth considering, especially since these tend to strengthen during times of economic uncertainty.
In conclusion, although the forex market does offer a certain level of safety from the negative impact of a recession, traders must exercise caution. Traders should pay close attention to economic indicators and adjust their trading strategies accordingly. Winning strategies include focusing on trading safe-haven currencies, as well as using stop-loss orders to limit potential losses. Still, it is important to remember that there is no such thing as a completely risk-free investment; therefore, caution and discretion are important.
Is forex trading recession-proof?
It is difficult to say definitively whether or not forex trading is recession-proof. However, if traders are aware of the risks and take the necessary precautions, they can still find success in the forex market during a recession.
What factors make the forex market recession-proof?
The forex market is one of the world’s most resilient financial markets and can provide a steady flow of income even during the worst economic times. The size and liquidity of the market acts as a buffer, protecting it from the worst effects of an economic crisis, while its decentralisation and diversification opportunities allow traders to offset risks. Despite this, the forex market is still not completely recession-proof and traders must be aware of the risks associated with trading in this volatile market. To successfully trade forex during a recession, traders should focus on currency pairs traditionally known as safe havens, as well as have a good grasp of the forces that influence currency pair fluctuations and how certain economies can influence one another.
What strategies can I use to successfully trade forex during a recession?
In order to successfully trade forex during a recession, traders should consider the size and liquidity of the forex market, diversification and decentralisation, currency pairs, and macro-economic factors. It is also important to understand the historical performance of the FX market during recessions. Additionally, traders should look at strategies like focusing on currency pairs traditionally known as safe havens, such as the JPY and CHF, and considering the effect of certain economies on others. By understanding all of these factors, traders can make informed decisions and potentially benefit from the recessionary environment.
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