Impacts of Sudden Exchange Rate Changes for UK Swing Traders
With transactions of over $5.1 trillion per day, the foreign exchange market, generally known as the forex market, is the world’s most traded market. Currency trade takes place 24 hours a day, 5 days a week across different markets.
The ‘major’ currency pairs are EUR/USD, GBP/USD, USD/JPY, USD/CHF, USD/CAD, AUD/USD and NZD/USD, while the ‘minor’ currency pairs are EUR/GBP, EUR/CHF and GBP/JPY. The commodity pairs include the USD/CAD, USD/AUD and USD/ NZD. By trading one currency for another, traders attempt to speculate on its future direction and profit by taking a long or short position.
An exchange rate is the value of one currency against another currency which equates the demand and supply for a particular currency against another currency. The exchange rate is quoted in currency pairs, such as USD/JPY, USD/EUR, USD/CHF, USD/CAD, EUR/GBP etc.
Let us take a look at an example:
Foreign Exchange Rate = Base Currency / Vehicle Currency
If we are calculating the exchange rate of USD/EUR, it is 0.82. This means that you can buy 1 USD with 0.82 EUR.
Factors that affect foreign exchange rates
The forex rates are influenced by many factors, including the demand for money and supply of money, inflation rates, interest rates, current account balance, economic policies, trade balances, and economic growth outlook. The Central Bank’s around the world controls the monetary policy and influences the interest rates of their respective countries.
Forex rates, interest rates, and inflation are interconnected. Ups and downs in market inflation can cause changes in currency exchange rates. For instance, a lower inflation rate leads to a rising currency value and a higher inflation results in depreciation in its currency with higher interest rates.
When the interest rate increases the currency is appreciated, making it stronger. Higher interest rates mean higher rates to lenders, and more foreign capital, which causes a rise in exchange rates.
On the other end of the spectrum, when the interest rates fall, investors avoid borrowing, impacting the economy and weakening it. The interest rates of a country have an indirect effect on the exchange rates and the differences between currency values can cause forex prices to change.
A country’s current account consists of the total number of transactions including its exports, imports, debt, etc. A deficit causes depreciation and leads to a fluctuating exchange rate of its domestic currency.
A national debt leads to inflation and a decrease in the value of its exchange rate will follow.
Key economic announcements
Economic announcements on employment, consumer price inflation, Central Bank meetings, or new events create the most impact and volatility so as to take advantage of their movements.
There are two kinds of exchange rates – flexible/floating and fixed. As the names suggest, flexible exchange rates change constantly, while fixed exchange rates rarely change.
There are a few currencies, like the Saudi Arabian riyal, that remain more or less fixed. They use fixed exchange rates that only change when the government says so.
Exchange rate risk
Exchange rates are volatile and a vital part of forex trading. Any fluctuations in the exchange rate can upset the calculations of even the most prepared trader. Any sudden changes in the rate of a currency that is traded in can result in gains but there is an equal risk that this could result in big losses too. Such blips in the rate can put pressure on cash flows and a major setback can even hamper regular trading operations.
Let’s take an example of the risk that lies in the fluctuations of the exchange rate you could be dealing in. Your base currency happens to be the USD and the trade happened with the GBP. Usually, once a trade is closed, the proceeds are in the foreign currency and subsequently converted to your base currency. In this case, the GBP is the foreign currency and the USD, the base. In the event of a sudden and sharp change in the exchange rate and your calculations are upset, the proceeds you receive of the trade will be lower if the USD is the loser. This is known as the negative exchange rate fluctuation between two currencies that can have a significant impact on profit margins.
Swing trading is all about trading medium-term and taking advantages of trades that can last from a couple of days to a few weeks in duration. It is primarily used by forex traders because they can take advantage of the price swings and make quick profits.
Swing trading suits volatile and liquid currencies that offer tight spreads. As a swing trader, you need to identify the ‘swings’ or price fluctuations within a medium term trend and capitalise on buying and selling the interim lows and highs within a larger overall trend. Technical and fundamental strategies will help you find the best trading opportunities. Swing trading makes it possible to profit from rising prices during a bull market and falling prices during a bear market.
Impacts of sudden exchange rate changes for UK swing traders
As we mentioned earlier, exchange rate risk refers to the losses that an international financial transaction may incur due to currency fluctuations. Other than a decrease in an investment’s value, due to changes in the relative value of the involved currencies, sudden exchange rate changes can have a wide-ranging impact for UK swing traders. The faster you get a grip on the significant movements and the overall price changes of the forex market, the sooner you can become successful in trading.
Sudden and huge fluctuations in the global foreign exchange market can be extremely challenging for a trader. Such fluctuations typically happen in both or one currency due to either development related to the home country of that currency. Examples are economic or political upheavals or any natural calamity or even extreme situations like strife or war.
But these changes can impact not just the base currency but the ripple effect it will have on the price of other currencies can create difficult trading conditions. Swing traders need to be particularly wary of these changes and monitor closely the extent to which the price deviation happens. It is important to analyse the situation and assess when a recovery could happen.
While swing trading sits in between day trading and positional trading, there are advantages that the other forms do not offer. But, from a risk standpoint, there are also many disadvantages when it comes to challenges arising before being able to close open positions.
The biggest risk obviously comes from the sudden exchange rate changes that crop up during the period of holding a position. Day traders have to close theirs before end of day and positional traders can hold theirs for longer. But, as a swing trader, you have to react to these exchange rate changes in a period of two days to about a week. Swing traders are subjected to the unpredictability of overnight risk and weekend hours that may result in significant price movements. Sudden exchange rates could cause a closing price to open at a much different price. This can put swing traders in a position where even a stop-loss is unable to spare them from a significant net loss.
How to avoid the impact of the sudden exchange rate changes for UK swing traders
Follow these strategies to ensure minimal impact of the sudden exchange rate changes for UK swing traders.
The stop-loss order
By placing a pre-set price limit, you can limit the losses in this volatile market.
Let us take the help of an example: if you have placed a buy order on USD/GBP at 0.71 and set a stop loss at 0.61 and a target level of 0.81 when the price moves below your entry and hits 0.61 your order is closed for a loss of 10 pips. Likewise, when the price moves to 0.81, your order is closed for a profit of 10 pips.
A limit order is buying or selling a currency for a specific price. By setting a limit order to sell or buy a currency will make sure that the trade will happen as planned. For example, USD/GBP is trading at 0.71 you have a limit entry order to buy at 0.80. Your order will not be filled unless you can get filled at 0.80 or better.
Another strategy to restrict losses, a stop order helps you exit a position if the price gets any worse than a threshold that is set.
For example, you went long (buy) USD/GBP at 0.71. To limit your maximum loss, you set a stop loss order at 0.65.
The position limit
There is a maximum amount of currency that is set by exchanges or regulators that a trader is allowed to buy or sell at any single time. The position limit makes sure that the trading risk is kept under control.
There are risks and losses once you enter the world of forex trading. This is because the value of a currency is always fluctuating in relation to another currency – the main reason being the relative differences in interest rates in each country. Sudden exchange rate changes often have a huge impact on UK swing traders.
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