Recession is inevitable。No one wants a recession, but forex traders prepared for a slowdown can turn fundamental changes in a country's economy into trading opportunities.。

What is a recession？

A recession is defined as a period of reduced economic and industrial activity in which an economy's gross domestic product (GDP) has contracted for two consecutive quarters.。This GDP figure consists of data provided by the manufacturing and service sectors of the economy。The value of both may fall, or the value of one may fall to the point of dragging the total to negative。

Other data points can show the fate of the economy and add more "color" so that traders can try to build profitable positions。Secondary data to watch include real income, inflation, employment levels, industrial output and wholesale and retail sales。As these indicators change, the demand for a country's currency is expected to rise or fall。

Historical Perspective of Recession

Overall, the period from 2010 to 2020 was one of a long period of economic prosperity.。It is characterized by interest rates and inflation levels remaining low as central banks injected cheap money into financial markets following the Great Recession that occurred from December 2007 to June 2009.。This is the longest contraction since the Great Depression of 1929.。

The tools used by governments and central banks to manage the economy can sometimes seem blunt and slow to act。At the same time, they may overshoot, leading the economy out of recession and directly into a period of excessive growth。This makes predicting the duration and severity of a recession a daunting task, which in turn leads to increased price volatility as analysts have widely differing views of the likely outcome.。

Foreign exchange market during recession

FX markets do not necessarily react in the same way as other asset classes during recessions。For example, the stock market usually depreciates during a slowdown, but the currency is more of a lubricant than a tangible part of the economic system。One trend that may occur is for the currencies of stronger economies to appreciate relative to those of economies that are experiencing more severe recessions.。

The reason why a country's currency may be more or less in demand is based on economic fundamentals.。A typical example is the currency of a major exporter such as Japan。During the global recession, Japanese automakers and technology companies expect demand for their products to fall。With much of the demand coming from global trading partners, any reduction in demand for Japanese goods would result in fewer yen being bought on the currency market.。

Recessions may also be short-term, local rather than global。This may be due to short-term political events such as the Brexit referendum, an unexpected result that has shocked the investment community。This led to a short-term contraction in confidence and economic production levels and caused the pound to plummet.。

Forex traders need to keep their eyes open for recession。Be prepared to trade successfully for short and long term currency price fluctuations using fundamental and technical analysis。

A currency that underperformed during a recession

Successful forex trading during a recession begins with conducting research and monitoring key data points such as interest rates。

Shrinking economies expected to get support from central banks and governments。One of the most effective and quick-acting policy tools is interest rates, which most central banks adjust at regular meetings - usually once a month.。

Lower interest rates help stimulate the economy as borrowing costs are lower。Both consumers and businesses benefit from increased cash flow, and a virtuous cycle of additional spending and production can kick-start the next period of growth。

Lower interest rates will also lead to lower returns for savers。If the other economy does not experience a recession at the same time, or at least outperforms the others, then interest rates in that country are expected to remain high.。Selling one currency and buying another allows depositors to switch to currencies that offer higher returns and affect the price of the corresponding currency.。

Devaluation of the currency through interest rate policy can also boost exports in recessionary economies.。Its products have become relatively cheap in the international market, which is another way for it to start recovering。As a result, the central bank sees interest rate cuts as a two-pronged approach to pushing the economy out of recession。As a result, even the threat of a recession can lead to lower interest rate forecasts and large swings in currency prices.。

Currencies that performed well during recessions

The currencies of countries with stronger economies are expected to strengthen during the global recession。Interest rates are expected to remain high as the central bank is concerned about both inflation risks and a possible slowdown in economic growth。

Fundamentals and Fear

It is important to consider the "fear factor" as well as economic fundamentals。Demand for dollars and Swiss francs is expected to increase during the global recession due to their status as safe-haven assets。This is because if a prolonged recession causes the global financial system to collapse and banks are at risk of default, it is best to hold currencies that are least likely to be run on by banks。

Low sentiment from recession could also cause big companies to scale back expansion plans。If US multinationals scale back ambitious overseas projects, this will affect currency prices。As investment in emerging markets declines, the demand for these countries' currencies will also decline, as there is no longer a need to buy developing countries' currencies。

Local Foreign Exchange Markets and the Global Recession

Depending on the type of recession experienced, the nature of currency price movements can vary considerably。During a global recession, one may feel that one currency is more prominent or that one currency is particularly weak。Currency exchange rates will fluctuate, but these fluctuations may be less extreme than if an economy is experiencing a partial recession。

Between 2000 and 2002, the Argentine peso (ARP) came under extreme pressure for its unrealistic peg to the dollar and triggered a banking crisis.。In this case, the run on the peso caused the value of the peso to fall from parity with the dollar in October 2001 to 3 a year later..51 pesos to the dollar。With the rest of the world's economies relatively stable at the time, international speculators were focused on the USDARP pair, and excessive financial flows led to lower prices。

How to trade Forex during a recession？

Forex trading during a recession is about how and what you trade。There are many forex strategies that can help you, but we've highlighted some rough guidelines you can follow to optimize your returns。

Investment schedule

It's always a good idea to have a clear strategy, but this becomes crucial when running a forex trading strategy during a recession。Investment schedules need to be carefully considered, as some recessions can last for years。In addition, day traders can also hope to profit from excessive intraday price volatility。

This makes it important to "run your winners" and keep trading profitable。Not every trade is profitable, and successful trading relies on cutting loss-making trades early and maximizing returns on profitable trades。

Selling Short and Buying Long

Every foreign exchange transaction consists of two elements, a process that involves buying one currency and selling another at the same time。

Choosing the right currency pair can make your trade win and thus maximize your gains。In the first half of 2022, those who think the ECB is unlikely to raise interest rates can sell the euro short.。

In terms of practicality, the obvious choice is to trade the euro against the dollar because it is the most widely traded currency pair in the world and the trading spread is small。However, alternative currency pairs may exist to provide better returns。

It is worth noting that between June 1 and May 31, 2022, the price of the euro against the dollar changed by 5.64%, but the change in the price of the euro against the Canadian dollar over the same period was 6.60%。Because the Canadian dollar is considered better than the euro and the dollar。

Managing Risk

Price volatility is expected to increase during the recession。"Frightened" investors can make volatile decisions, and uncertainty about the effectiveness of policy measures can lead to very different views of where prices should be.。

As a result, foreign exchange trading during recessions can benefit from a reduction in position size and leverage。This leads to price volatility, which may be greater in percentage points and smaller in cash terms。Smoothing returns and building the ability to hold positions is part of being a sensitive investor and getting consistent long-term returns。

Looking for signals

Forex trends can last for months or even years, but don't expect every trade to be a winner from day one。Using a VWAP strategy to average open a position allows you to gradually average open a position instead of taking a full bet and risking being eliminated before the trade actually starts。Using a range trading strategy can help you trade when a currency pair reaches the edge of its natural short-term price range。

Conclusion

Forex trading during a recession needs to take into account some of the unique characteristics associated with an economic slowdown。The first step is to determine whether any recession is local or part of a global trend, as this will provide clues to the nature of subsequent price movements.。Then, wait for expected changes in currency pair prices to adjust to reflect the situation in the underlying economy。