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COVID-19 (coronavirus) gripped 2020 at an unparalleled pace, driving the global economy into its worst recession in decades. It’s estimated to cause global Gross Domestic Product (GDP) to contract by 4.4%.
With so much uncertainty, does it not make sense to avoid financial markets and save cash at the bank, via money market accounts, for example?
Despite alternative options, interest in the foreign exchange market (currency markets) has increased substantially, with volatility surging, even during an economic recession.
Forex Trading: A Two-Way Market
Most have heard of the age-old adage of buy low and sell high.
However, what if price is already high? Sell first? Although possible, some financial markets such as the stock market (in some countries) do not permit this practice. In Wall Street parlance, this is called naked short-selling. It is based on the premise ‘you cannot sell what you do not have’.
To understand the logic, reverse the above statement: ’you can sell what you do not have’. At the very least, embracing the concept of ‘selling what you do not have’ may fuel speculative flames which is why some regulators frown upon it.
In contrast, Forex traders are permitted to sell currencies they do not have, due to FX not only offering a two-way market system based on currency pairs, but also due to the fact FX is offered via derivative products. Apart from Forex, other two-way markets you can short-sell include commodities and cryptocurrency CFDs. The latter is an exciting trading space at the moment, with bitcoin recently testing all-time peaks.
Another point worth highlighting is Forex markets, or currency trading, is global, substantially larger than the world’s biggest stock markets, such as the New York Stock Exchange (NYSE). Trading in FX markets reached $6.6 trillion per day in April 2019, up from $5.1 trillion three years earlier. Due to its mammoth size, liquidity is rarely an issue (the ability for a currency pair to be bought and sold).
Why Two-Way Markets Will Always Have Potential for Returns
All markets exhibit either an uptrend (a bull market) or a downtrend (a bear market). Bear in mind some currencies may also be labelled as ranging, flat or sideways. The market is said to be ranging when the price of a financial instrument forms similar highs and lows, with no discernible trending action.
When formulating an FX trading strategy, keep in mind two-way markets are viewed as a zero-sum game. Some economists may view this negatively. However, if two-way markets are a zero-sum game this also means there will always be a constant percentage of winners in the market, regardless of the economic cycle or whether we’re in a financial crisis or not. Think of it as a filter – an efficient way of filtering out uninformed traders.
By selling (or shorting) EUR in the EUR/USD currency pair at a time the Eurozone starts to experience a recession, your trading account will move into profitable territory despite the Eurozone’s economy taking a hit. This is a clear example of FX trading benefits, where even day traders are known to make enough money in a day to weather the tide of a year-long recession. Conversely, in the above example, if you were bearish US dollar (USD) at that time, a loss would have been incurred.
To remain on the winning side of the table, even during time of a recession, traders must employ a trading system, one that incorporates both fundamental and technical analysis. This helps generate informed decisions and maintain strict risk and money-management principles.
DISCLAIMER: The information contained in this material is intended for general advice only. It does not take into account your investment objectives, financial situation or particular needs. FP Markets has made every effort to ensure the accuracy of the information as at the date of publication. FP Markets does not give any warranty or representation as to the material. Examples included in this material are for illustrative purposes only. To the extent permitted by law, FP Markets and its employees shall not be liable for any loss or damage arising in any way (including by way of negligence) from or in connection with any information provided in or omitted from this material. Features of the FP Markets products including applicable fees and charges are outlined in the Product Disclosure Statements available from FP Markets website, www.fpmarkets.com and should be considered before deciding to deal in those products. Derivatives carry a high level of risk; losses can exceed your initial payment. FP Markets recommends that you seek independent advice. First Prudential Markets Pty Ltd trading as FP Markets ABN 16 112 600 281, Australian Financial Services License Number 286354.