Updated: Jul 20
Beginner Friendly Guide to Forex
Since the start of COVID-19 in March there’s been insanely volatile financial markets. The stock market and the forex market have been hit by COVID-19 it can be seen directly in the price of various assets.
The United States currently leads the world in not only economic output but also in a not so proud factor, COVID19. You can see that during the inception of COVID19, there’s been an exponential growth rate in cases and deaths during March and April. This forced the U.S. Government into targeted restrictions and lockdowns within the United States but many of those have since been lifted.
The interesting relationship with the pandemic and the forex market is a prime example of risk on and risk off investor sentiment. When everyone heard of the pandemic, they got scared, spent less and stayed inside. This type of behaviour has a ripple effect on the economy itself which we’ll get into now.
his is the ISM PMI data from 2019 to date which is super important when trading forex. During the new year you could see that producers and manufacturers in the United States were actually quite optimistic of future output moving into 2020 but the black swan event of COVID19 changed everything. The data in January showed a reading of 51 which basically meant businesses were confident in the future and they’ll probably make money. However, in April’s reading you can see the ISM PMI data drop a whole 10 points. This was a huge contractionary reading for the US economy and US business confidence.
There’s a direct correlation here when COVID19 cases are increasing business confidence suffers. It’s also why when trading forex you see the riskier currencies go down when global confidence falls down.
Since then we have reached new highs on the ISM PMI, which is a great sign, but this may due to Donald Trump allowing businesses to open and easing restrictions. Many domestic businesses and consumers do not like the idea of having to open up their doors as it puts the health of themselves and workers at risk. This could be a core reason why it’s forecast to drop back down to 51.4 next month. If the COVID-19 creates a spike in cases it could lead to targeted lockdowns which may affect certain businesses.
This is UMCSI consumer confidence in the United States. It’s a great indicator on what consumers (the people) in the United States are likely to do in the future. When they’re not confident they won’t spend in the economy and when they are, they’ll happily spend and take on more credit.
What we’ve outlined on the indicator are extreme levels of consumer sentiment. Generally, when US consumer confidence reaches a level of 100, it tends to be that consumers are getting overconfident. They’re now so confident that the reading is difficult to get any higher and most likely things will take a turn for the worst.
You can see during 2000s consumer confidence was at an all time high, this was the exact same time a recession took place during the dot com bubble. Similarly, between 2002 and 2007 consumers felt confident but then as time went out more and more consumers started to feel hesitant about the future.
The most recent readings have shown history repeat itself with consumers between 2018 and 2020 showing confidence and then as soon as COVID19 happened the indicator dropped below 80.
Why am I going over business and consumer confidence? How does it have anything to do with trading Forex or trading stocks. Well, we’ll jump into that now and show you exactly why you need to take into account reports like this in your analysis.
This is the GBP/USD currency exchange rate and the Orange line is the S&P500 an overall stock index of the US economy. You can see directly from the chart that both the S&P500 and GBPUSD are positively correlated.
How did COVID affect stocks and forex?
If you remember COVID19 started in March. In the same time period, the GBPUSD exchange rate dropped 10%! Imagine shorting GBPUSD with an unleveraged gain of 10%, if you leveraged 2/3x there would be a gain of over 30%, this is the power of using fundamental data to predict the forex market.
What about stocks? The S&P500 stock market dropped over 24%. You can see the direct correlation here of how COVID19 can have a negative impact on investor sentiment and thus both the forex and stock market. Another interesting factor about this data is that you can see how much more volatile stocks can be in comparison to Forex.
What do we expect later moving forwards? I’ve outlined 2 red lines which were levels that sellers came into the markets. We call this a Supply zone or sell zone in forex. Very recently on June 10th GBPUSD hit this supply zone and then instantly we saw sellers jump into the market and start selling. This is similar with the S&P500 which dropped a few % once it hit those levels too.
What we’re expecting is that if COVID19 cases start rising at faster rates again it will further cause a dip in business and consumer confidence which generally leads to both the GBPUSD exchange rate and S&P500 index to drop. That’s why we need to keep an eye on those levels and economic reports when trading forex or stocks. If you’re just looking at price alone, you’re really missing the bigger picture.
Why do we need to take into account economic reports and events like COVID-19? Well, if we look at the COT chart above in the pink line, we see hedge fund positions in the market. During that same period of economic reports signaling a recession and COVID-19 news popping up everywhere the hedge funds were shorting the GBP. They were selling risk assets and buying safer assets. They’re the most profitable participants in the markets and it’s important to think and trade like them if we want a chance at succeeding in the forex market.
If there’s one thing to take from this article:
Risk off = investors, consumers and businesses are scared. (Risk assets go down; safe assets go up)
Risk on = investors, consumers and businesses are confident. (Risk assets go up; safe assets go down)
When COVID19 cases and infection rates get too much to handle then we have a “risk off” environment. When they’re starting to slow and fall we have a “risk on” environment.
If you’re interested in learning fundamentals and about economic data you can watch our free fundamental trading webinar here.