Forex traders need to stay aware of policy makers' motives
Since the financial crisis the global economy has been gripped by near constant volatility, uncertainty, complexity and ambiguity leading to an almost permanent interventionist stance by central bankers. This has created difficult markets for some forex traders.
And those interventions have been dramatic.
There's been the quantitative easing programmes of the US Federal Reserve, the Bank of England and now the Bank of Japan. The Swiss National Bank effectively killed any prospect of serious CHF rallies by putting a cap on the exchange rate. And even the European Central Bank may this year join the party with some new shock and awe of its own.
Forex traders often find that perfectly valid calls based on technical analysis, sometimes even supported by fundamentals, are rendered useless because a central banker thought their currency was becoming too strong and said so.
This environment has made the carry trade a more risky strategy along with systematic trading strategies based on following trends. Those strategies are more vulnerable to the short sharp bursts of action, which are typical of news and event driven markets.
ECB governing council – considering more intervention
Systematic versus discretionary
The current environment, which could persist for years given fears over deflation and the constant focus on exports, could persist for years. To be successful forex traders have to be adaptable.
This has made discretionary trading more popular – where trades are based more on judgement calls rather than signals generated by a system. Since 2008 funds run by discretionary traders have regularly outperformed those using a systematic approach.
However, while the discretionary approach can work well for talented traders, it does have the flaw that there are so many variables in the forex markets, particularly these days, that it is difficult to assess their importance or even be aware of them all.
Where the systematic approach still plays a strong role is when it is being used over shorter time frames, anything from a few minutes through to a couple of days. That means capturing smaller trends and movements more often, but trading more regularly, does of course come with its own set of risks.
But whatever approach forex traders take, they do need to understand the position of policy makers, their motivations and the dynamics driving their decision making. That means reading their speeches and thinking carefully about what they mean and how their comments will translate into action.
The fact is the world economy is still fragile and has huge debts. That means policy makers are likely to remain interventionist for a long time. Therefore forex traders will need to be more flexible and adaptable and get used to seeing trends quickly destroyed when they go against the wishes of certain policy makers.
By Justin Pugsley, Markets Analyst
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