What Historical Forex Crashes Teach Modern Traders
Modern traders have at their disposal more information than any professional in the past. A lot of traders rely almost exclusively on their knowledge of the market, hoping that an unexpected crash will not occur, as it did years ago.
A study of the events around past forex crashes will show how different currency pairs, as well as the overall market, behave under pressure, which is an extremely valuable tool for traders participating in the foreign exchange market.
History Will Repeat Itself (Forex Crunch)
Crashes in forex are usually a result of a mix of political, financial, and monetary action taken by governments and investors. These events usually impact the value of currency pairs directly, if not all at once. Currency values can plummet due to a loss of faith in a particular country, higher interest rates, and government and policy intervention in the marketplaces.
A careful study of history will help traders realise that their carefully crafted strategy will often not work during periods of high market volatility.
Importance of Risk Management
One of the key points all professional traders will say regarding risk management is that a trader must protect himself from severe losses as much as possible. Large and unexpected currency fluctuations can swallow a considerable portion of a trader’s account, especially if using leverage.
Leverage, although it can boost the performance of the account, is known to do the exact opposite if a trader is not prepared to manage the risks that come with it. Implementing a proper money management strategy will allow a trader to withstand unforeseen market fluctuations with minimum losses.
Leverage Can Be Extremely Dangerous
A crucial lesson modern traders should learn from history is that leverage can be extremely dangerous. In normal market conditions, a leveraged position can boost a trader’s returns. However, during market instability, the results can be devastating.
The trader may watch his account balance drop helplessly as the price moves against his direction. During extreme market conditions, where the price moves at the speed of light, traders may not be able to exit their position at the desired level. Furthermore, the exit price may also be different from the one the trader expected.
This is an essential lesson for all those participating in the online forex market: having access to leverage does not mean that one should risk it all by using all available leverage.
Market Conditions Change (Crash)
The next thing traders should learn from the history of forex crashes concerns market conditions. They can change rapidly at any moment regardless of market trends. Indicators, as well as the movement of previous prices, should be seen as a helpful guide, although definitely not foolproof.
The market is unpredictable, especially during extreme conditions. Trends and support/resistance levels that have shown results during past periods of range-bound volatility may be broken with a few clicks of a mouse.
This is another crucial aspect that should be known by everybody participating in forex trading online: during moments of change, traders should re-adjust their risk/reward ratios. It is also essential not to increase the size of a trading position simply because a certain market trend “looks right” on a daily chart.
Economic News Often Influences Currency Movement
Economic and political news often influences the value of currency pairs. News reports about changes in central bank interest rates, government policies, financial and market stability, and inflation rates, among other things, play a major role in influencing forex traders and investors. The political situation in a country or unexpected adverse weather conditions can also dictate the movement of currency pairs.
Furthermore, the market may react not only to the actual report but to the fact that the result was different from the one anticipated by investors and analysts beforehand.
Emotions Can Take Over
The extreme market volatility can severely impact an individual emotionally, causing his judgment to be flawed more often than not. The feeling of hopelessness and loss of money can give rise to desperate attempts to chase losses by increasing the size of a trade with the expectation of a rapid recovery of capital when a big price move finally occurs. Alternatively, one can also start ignoring essential elements of his trading plan such as stop-loss, take-profit, or position sizing due to frustration.
Another crucial point to consider for all participants of the foreign exchange market: never try to chase your losses after a big loss. When a trader loses a significant amount of money, his natural reaction is to want to quickly recoup this amount either by increasing the size of an open position or by opening several new positions quickly in an effort to recover his losses fast.
Instead, it is best to give your mind a moment to cool down and analyse the objective path forward.
Diversifying is Not A Cure-All Wonder Drug
Diversification, while it does reduce the risk of a trader greatly, is not without its shortcomings. The behaviour of individual currency pairs or market indices varies during times of market instability. During periods of high volatility, the relationship between two currency pairs becomes much tighter, while others suffer. A trader must know the risks pertaining to each respective side of his trading position. Simply saying that he knows nothing about the currency pair because he holds other positions is not enough to protect him during extreme market conditions.
Preparation Helps
One of the final things a trader should learn from the history of foreign exchange crashes concerns being prepared for market changes. Instead of waiting for the unexpected crash to happen, make a plan stating how much you will risk during a period of high volatility.
History has shown that during times of market turbulence, there are certain periods when the overall market moves up and down. It becomes vital for a trader not to overexpose himself, to keep an eye on economic calendars and major market news, and to have enough capital to stay in the game and withstand the volatile price swings.
A Look Into the Past
It is essential to keep a balance between risk and reward, using the proper money management techniques. A wise trader will not increase the size of his position just because it looked good during a period of calm market conditions. It is equally wise to realise that diversifying one’s portfolio is not a cure-all wonder drug to protect one from massive losses.
Emotions such as panic and frustration often cloud the judgment of traders and make them make unwise (and expensive) decisions. Keeping track of economic events is also of vital importance because sometimes the market reacts not to a particular event but rather to the realisation that the result was different from expected.
The most important thing to remember about history is that it is there to provide one with knowledge, not to give away some holy insights.
Conclusion
History will repeat itself; there is no doubt about that. With that being said, it will seldom repeat in the exact same way. A thorough study of historical data and research will educate a trader on the proper approach concerning risk-to-reward ratios as well as proper money management.
The primary goal of any trader should not be to chase every single swing of the market, but rather to keep calm and focused, following the basic tenets that the greatest players in the business have been following for decades.
