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Covid-19: Trading FAQs Pt. 2
We hope that the first part of this series helped you to navigate trading in the midst of the COVID-19 outbreak. In the second part we’ll be talking about profitability during a crisis, the importance analysing a market trend and what assets pose an investment risk.
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1. What is a currency crisis?
The current situation has inevitably led many to ask the question. Are we approaching another 2008-type financial crisis? The jury is still out on this one. Currency crises unfold when radical depreciations in a country’s currency occur. This in turn has a knock-on effect on speculation within the financial markets.
Currency crises are often difficult to predict and happen due to a number of contributing factors. The principle factors are often currency speculation, large financial deficits and central bank policies. However, a look back at previous crises shows that a primary cause was the central banks’ inability to maintain a fixed rate peg to a floating rate foreign currency or excessive money printing.
During a currency crisis, investors should try to remain cognizant. So, make sure that you have a well-thought out trading plan, manage and lower your risk. Furthermore, try not to place all your eggs into one basket, since a well-diversified portfolio will help you to protect your assets.
2. How does the COVID-19 market meltdown compare with other great downturns, such as 2008?
Despite the rising unemployment figures and the uncertainty looming large, there still are rallies across various fiats and crypto. For instance, we have seen the US Dollar gain momentum as the market turns into risk adverse.
There are more differences than similarities between the two crises. Leading experts, economists and central banks’ CEOs are assuring us that the scenario is different since there isn’t the risk of systematic failure. The 2008 global financial crisis originated in the US and was primarily due to bad debt that effected the real economy. In contrast, today we are facing a global health pandemic. Lockdowns and other restrictions are causing shocks and creating knock on-effects on businesses and in turn, the financial sector. We have seen stimuli put in place as a way of boosting economies and managing the potential risk of the COVID-19. However, have we become to dependant on monetary fixes? Central banks do not have the ammunition to solve a health crisis that can only be resolved by “flattening the curve”.
The outcome of the current situation remains unknown, but we can seek comfort in the fact that the two scenarios are different and the likelihood of history repeating itself is low.
3. How can you identify a market trend?
Trading can be complex and a crucial element is knowing how to identify market trends. A trend can be defined as the perceived movement of financial markets in a particular direction. When a market is trending, it is predominantly bearish (downward), bullish (upward) or sideways. To define the direction of a trend traders can use various forms of technical analysis, trendlines and indicators.
Indicators are essential to identify trading opportunities and market conditions. Very often traders use multiple indicators to form a strategy such as:
a) Trend Indicators: These are designed to show traders and investors the trend or direction of the asset that they are trading
b) Momentum Indicators: The momentum is a measure of the speed at which the value of a security is moving in a given period.
c) Volatility Indicators: The volatility is the relative rate at which the price of a security moves. High volatility occurs when the price moves up and down quickly over a short period.
d) Volume Indicators: The volume of trades is a very important component. It is used to confirm or inform a continuation or change in a stock direction. Volume indicators include ease of movement, Chaikin Money Flow, on balance volume, demand index and forex index.
Market trends are determined by analysing and comparing historical data. A trend line is a technical analysis tool used to illustrate where two or more points connect.
- An upward trend will have a positive slope and are formed when a series of low points connect. Characteristically the second low is greater than the first.
- A downward trend occurs when the second high is lower than the first and so lead to a negative sloped formed by a series of high points.
We would never advise to trade against trends, especially if you are new to trading. Unless you have acquired the patience and financial resilience to stick to a long-term plan, don’t bet against the main forces of market momentum.
4. Should you trade in a downturn and can you still be profitable in a crisis?
Downturns can have a devasting effect, however, dexterous traders have been able to profit in these situations. Observation is key here, monitoring the driving forces of a downward trend and the situations across all markets help traders predict if the currency is ripe for a crisis. Forex trading offers the added benefits of continuous market hours and the cryptocurrency market never closes. So, traders have access to their investments 24hrs a day 5 days a week and can amend their investment according to market sentiment.
Doubtlessly, fear can cloud rational judgment, but some traders might that they prefer trading during a market crisis. Read our article “How Forex Trading Is Profitable In A Downward Trend” to identify better bear markets and understand how you can make the most of the market crisis.
5. Are certain assets less risky than others?
All investments carry an element of risk, but with a different risk/reward profiles – each asset has specific benefits, but certain assets have a safe haven status.
Commodities are risky. This is mainly due to the fact that they are traded on futures markets that offer a higher leverage level.
Stocks generally have higher earning potential in exchange for a higher risk. They have the potential to climb over time and be very valuable to investors. For instance, Apple and Amazon, have surpassed the trillion-dollar threshold and bring very substantial gains to have owned stocks for years. Nonetheless, the principal disadvantage is that investors have no guarantee of return. Investors rely on the stock prices to rise for dividends to be paid. Additionally, dividends can also be cut at any time,
particularly, in times of crisis. Stocks can be volatile, and so it’s not uncommon for a stock’s price to fall by 50% in one trading year.
When trading stocks, try to avoid:
a) Investing without conducting research.
b) Buying too many stocks or funds just to diversify.
c) Buying insurance to save tax.
d) Not saving for emergencies.
Currency trading (Forex) is less risky than other assets. Indeed, it is rare for traders to witness a drop over 2% within the forex market. A major crash would typically require a catastrophic event such as that of the Swiss Franc “Flash Crash” in 2019.
It goes without saying that the market tends to be more volatile during stormy times. These occasions require traders to be more conscious about what is happening on the news and in the market. The foreign exchange has many advantages, that are suited for times of crisis.
- The market is open 24hrs, 5 days a week and so traders have the opportunity to react to certain events in real-time. Conversely, with other assets traders might find themselves sitting on the fence which leads to more frequent losses than in forex.
- Many exchanges forbid short selling during a strong crisis to avoid the acceleration in the drop. With forex there is no shorting, you can take any position going in any direction.
Cryptocurrency is the new kid on the currency block and at times it is still misunderstood by the mass market. CoinDesk’s Jill Carson notes that a low risk tolerance was her reason for getting into Bitcoin.
After the major stocks sold off in August 2019, some experts went on to describe Bitcoin as a safe haven asset. This statement was justified due to the negative correlation between S&P and Bitcoin’s pricing. The market cap for the entire crypto industry fell by over $10bn since the Covid-19 outbreak. This was mostly driven by BTC price consolidation below $7k and if history repeats itself, the crisis has proven relatively beneficial, particularly for Bitcoin. (Check out our views on BTC pricing history here and our thoughts on the mass adoption of crypto here).
Overall, we recommend that investors have a balanced portfolio to ensure smoother potential returns and less volatility.
6. How do I know my trading plan is working or when to change my approach?
The short and simple answer is that if you are turning a profit then it’s working. It is important to note that Rome wasn’t built in a day and traders will never be right 100% of the time.
If we fail to prepare, we are prepared to fail and the same goes for trading. Planning and organisation ensure that traders don’t lead with their emotions when things go wrong. There is no one plan fits all approach, and every trader needs to conduct personal research and build a plan that suits individual needs. While putting your plan to the test in real market situations is crucial, analysing your trades is another key element that can help you can improve.
Many traders fail because they don’t adapt to market conditions. Markets are volatile and unpredictable, consequently plans need to change. Test the waters before you dive head first and continue to test your plan regularly. It’s important to keep in mind that there are no winners or losers in trading instead your mentality should be fixed on profitability.
That concludes the second part of our COVID-19: Trading FAQs series, we hope that you found this information useful. Should you require further assistance reach out to our Support Team and we will get back to you within 24 hours.