What Happens to the Forex Market During a Recession
With the black swan event that was Covid 19, it’s clear that there have been some long-lasting economic impacts across many countries in the world, with various countries entering a recession. Recessions are typically indicated by a general decline or shrink in economic data points and a decline in GDP for at least 6 months, or two quarters. The forex markets are, of course, closely tied with economic data – but where does this leave forex traders?
In this article, we are going to look at the impact of a recession on the forex markets and understand whether you should be trying to trade through such a volatile time in the markets… So, let’s find out!
The Impact Of Recession On The Forex Market
Recessions and black swan events can play havoc with the strength of currencies and lead to some fairly giant moves in the forex markets when compared to other currencies. More cautious traders may think that this proves a nightmare and should be avoided at all costs. However, the increased volatility can provide a great deal of trading opportunities for traders looking to capitalize on large swings in price within the markets.
Short term traders are not really going to feel any effect of recessions in the markets due to the fact they’re only holding trades for a few hours at a time, or even less! Many of our Elite Funded Traders that focus on the short term rarely focus on fundamentals.
For example, take this trade on EURUSD below…
For a trader solely focused on price action, the New York open volume plus a valid buy opportunity from a price action standpoint is enough to get in and out of the long within an hour. Regardless of any fundamental factors, this trade will be valid.
However, it’s long-term traders that are going to suffer or succeed during these times of economic turmoil, as they have the chance to ‘ride the wave’ as currencies fluctuate massively. We’d recommend building a robust trading strategy that can weather large draw-downs to stay afloat if the worst comes to the worst! Some trading strategies will stop working during certain market conditions, so you must be aware of this!
Should You Be Long Or Short In A Recession?
In many markets, traders are only interested in going long and holding their investments for as long as it takes to earn a profit. However, in the forex markets, you’re able to go short without incurring any additional risk thanks to stop losses. This means that for traders, it doesn’t really make a difference if you’re looking to capitalize on the strength or the weakness of a currency!
Your ability to either long or short a currency will depend on a few factors, during a recession…
- The interest rates and changes made.
- Government debt levels.
- Geopolitical influences.
These factors are going to give you a clearer indication of the strength or general weakness of a currency at the time of a recession. This should frame your decision whether you’re looking to buy or sell against other currency options. I’d recommend building a picture of the fundamental strength of all major currencies – then building out a set of potential trading options using technical analysis that provides entry points for the fundamental bias.
For shorter term traders looking to only stay in the markets for a few hours at a time, there will be little benefit of analyzing the long-term position of these currencies. They’ll be in and out before any large moves occur!
A side note, it’s worth remembering that you can backtest your strategies through past recessions to work out how you would have performed trading those market conditions!
Should You Still Be Trading Forex During A Recession?
There is really no firm answer whether you should be trading through a recession because it largely depends on your trading strategies and risk tolerance. The only real downside of trading through a recession is potentially increased volatility within the markets, which may lead to increased losses and price action becoming void. However, this potential for increased volatility is also great for traders to capitalize on, so there are certainly benefits for keeping your trading lights on! Whatever you decide, we always recommend that our prop firm funded traders reduce their risk to manage draw downs during periods of increased volatility.
For day traders, intraday traders and scalpers, you’re almost immune to any economic factors in the world! Whether the price of a currency is sharply increasing or decreasing against a basket of other currencies, there are always going to be normal price action patterns happening on the lower time frames.
For example, if you look for a large bullish push on the daily time frame – you’ll always find plenty of buy or sell opportunities on the 5-minute time frame.
For swing traders and position traders, you’ll be more affected and need to be much smarter with which longer term positions you’re looking to enter. However, if you get this right – you’re going to have some potentially huge swings on your hands.
For swing traders that primarily trade price action, I’d recommend utilizing and learning fundamental trading to go alongside your skillset of technicals – to ensure you’re taking the right trades and able to hold them for a longer duration during a recession.
What Happens To Gold During A Recession?
Gold has always been known as a safe haven for investors during times of increased volatility and recession. This isn’t just a rumor, and it can be a great place for traders to focus their efforts, as Gold usually sees an increase in price during volatile periods. It’s worth remembering, however, that as leveraged forex traders you can easily go long, but also short the market – this means you can still make large profits on currencies that are decreasing in value. This opens the door to still being able to trade a whole range of pairs during a recession – however, gold is going to be a good bet!
In Conclusion – Will A Recession Impact Forex Traders?
In summary, during a recession, the forex markets will become less predictable and much more volatile for traders looking to take long-term positions within the markets. However, for traders focusing on intraday trading, there will be little impact! If you’re looking to stay ahead of the markets, you’ll need to understand the fundamental factors driving the recession and how these will impact the price of the currency. However, short term traders need not focus too much on this as regardless of the strength of a currency, they will still be able to scalp positions!