Why does a forex pair price suddenly change direction ?
Imagine a situation where a currency price is rising, then, it suddenly starts to fall. And maybe continues falling a little further. And then it begins to go back up, sometimes, unexpectedly and without warning.
Have you ever been in such a trading situation ?
There are many explanations why this happens and you can be able to stop losses and even make a profit if you know exactly what’s going on.
This article deals with some of the factors that cause the sudden shifts in the price of forex currency pairs.
Forex is ruled by trends
A trend is a tendency for prices to shift in one direction over a period of time. Trends can be short-term, long-term, downward, upward, and even sideways.
Success in the forex market is tied to the ability of the trader to detect trends and position themselves for profitable points of entry and exit.
Note also that when a market moves in either direction, prices continue to move away from the channel and return to the channel as volatility rises and declines, respectively.
Prices often tend to return to the mean over a period of time with volatility. This turnaround to the mean offers incentives to either buy or sell based on trend direction.
Some trends are more powerful than others.
In fact, some trends can be so strong that prices form a parabolic or j-shaped curve, jumping abruptly from one position to another, and at often without warning. In other situations, sudden reversals may occur, in which a currency pair’s price unexpectedly changes direction.
Forex is ruled by volatility
From the above, it is easy to conclude that the forex market is a very volatile market, where prices can change unexpectedly.
Forex volatility refers to fluctuations in currency on the global foreign-exchange market. Based on a large range of variables, price changes will vary from hour to hour, second to second.
There must be price swings when it comes to making money on the financial markets, with forex volatility being especially vital for short-term investors.
For example, day traders rely on hourly price changes and there would be no room for profit without any fluctuations.
Volatility is also important for swing traders who operate on a slightly longer (usually days or weeks) period.
Swing traders also use technical measures to monitor the market’s volatility and determine when to exit and sell best. Such metrics can help forecast patterns in bullishness and bearishness.
Liquidity in the market has a major effect on how unpredictable the prices are.
Lower liquidity typically contributes to a more volatile market and causes dramatic price changes; higher liquidity generally produces a less volatile environment where prices do not fluctuate as dramatically.
More traders trading at the same time typically leads to minor movements up and down in price. In the forex market, however, dramatic and unexpected changes are also possible.
Since currencies are influenced by so many economic, political, and social activities, there are many occurrences that lead to volatile prices.
Traders should be aware of current affairs and keep up with financial news so they can locate potential profits and avoid potential losses better.
When currency price shifts in a forex trade unexpectedly, depending on how long the shift will last, it can either be a reversal of trend or a retracement of trend.
What is a trend reversal ?
A trend reversal is a shift in the course of an asset’s price. A reversal to the upside or downside can occur. A change will be to the downside, after an uptrend.
Some indicators, such as a moving average or trendlines, can help to distinguish trends as well as to spot reversals.
Reversals often occur in intraday trading and occur very rapidly, but occur over days, weeks, and years as well, and when this happens, it automatically changes the direction of the currency pair price.
Reversals take place on various time scales that are important to different traders. An intraday reversal on a 5-minute chart doesn’t matter to a long-term investor watching regular or weekly charts for a reversal. Yet for a day trader the five-minute reversal is very vital.
If reversals were easy to detect, and traders can differentiate between noise and brief pullbacks, it would be easy to trade. But this is not so.
When using market action or indicators, there are often false alarms and often reversals occur so rapidly that traders can’t move fast enough to prevent a big loss.
What are Trend Retracements ?
A trend retracement is a temporary price change against the existing trend.
Simply, any temporary price inversion within a major market trend is a retracement.
There is a major difference between a reversal and a retracement. A reversal is the end of the price trend, and either the start of a new one or the start of a consolidation phase. Whereas, a retracement happens as sudden price change during the phase of a major price trend.
Another way to look at it is as price movement that is heading against the trend but later returns to keep the trend going.
It is only until a lower low and lower high is rendered by an uptrend that the trend is called into question and a reversal may develop.
What Should You Do in the face of a reversal or retracement ?
In the case of a potential reversal or retracement, you have three options:
- If you are in a position, you could hold on to your position. If the retracement turns out to be a longer-term reversal, this may lead to losses.
- If the price starts rising again with the overall trend you could close your place and re-enter again. Of course, if price is heading sharply in one direction, there may be a lost trade opportunity. If you want to re-enter, money would be lost on spreads too.
- You could also permanently close. It may result in a loss (if price does not go in your favour) or a big profit (if you closed at the top or the bottom) depending on the trading arrangement and what happens afterwards.
Since reversals can happen at any moment, it’s not always easy to choose the right choice.
That’s why when dealing with the trend, using trailing stop loss points can be a perfect risk management strategy.
What causes sudden price change in forex ?
Volatility’s primary driving force is trader or market sentiment and the following may have significant influence on this sentiment.
- Economic news such as a release of data or announcement by central bank.
- Changes in interest rates;
- A change in political leadership
- News like a new product for the company.
- Recommendation from respected analysts.
- Herd mentality, when traders take after other traders without first analysing.
Also, governments’ overall efficiency, and especially changes in a government’s borrowing level, influences currency markets and can influence price direction in the forex market.
This is particularly true for when there is perceived uncertainty with the political or economic state of a nation.
Increases in government borrowing will not only to devalue their currency by raising its inflation rate, borrowing from citizens in other countries would also continue to decrease the currency of the borrowing country.
The overall market conditions of a nation can also make a lot of difference, because poorer economies when compared to each other will mean that there is likely to be less demand for a currency of a nation that struggles more economically and will lower its relative price.
In periods of economic instability, people will generally choose one currency over another, especially the one they perceive to be stable, for example by shifting money to USD, which is perceived by many as more stable than many other currents. This will by itself increase the demand for the currency.
In addition to all this, speculation also drives forex markets, however, speculation represents a small part of forex transactions and thus has less impact on those markets.
How to predict the forex market
A trader must have a detailed understanding of the factors that may influence the movement of exchange rate of a currency if they wish to succeed.
Note-there is no definitive Forex prediction formula. It all depends on your own knowledge, experience, the precision of your foreign exchange forecast and your dedication to success.
The five factors you need to understand are:
Geopolitics or political stability
Imports and exports
If you track all activities, micro and macro factors meticulously, you have much greater chances of making your predictions effective.
But you should realise this is not an easy thing to do. There are some sites offering so-called free Forex forecasts, but as they are not accurate, you should avoid these.
Many experienced FX traders use a Forex calendar to track economic announcements, predictions, and other important information relating to Forex.
One of the essential talents a Forex trader should have is being able to identify trends, as it can prove highly useful when making any prediction on the Forex market.
The trend is a general market direction of an asset price. Trends can differ in length, whether short to intermediate, or long-term.
If the FX market’s general trend is going up, you should be careful and attentive about taking any positions that may depend on the trend heading in the entirely opposite direction.
But be warned, this does happen as a reversal or retracement can occur. However, your forex strategy should be able to help out here.
Being able to make forex market predictions is not an easy feat. It requires continuous analysis of the market, and good skills in taking advantage of different kinds of strategies and trading platforms.