FX volatility is still with us as liquidity drops due to the virus but what’s driving the lower rate of business?

This is something we’ve been talking about in our trading room today. When we talk about FX markets, most of our focus is on large banks and institutions providing the liquidity on which we trade. What we often forget is all the layers below that, the everyday side of the market, call it the commerce side. The FX market is a $5tn a day market and that’s formed from thousands if not millions of deals done each and every microsecond. Every 0.0001 pip move you see on your platform is a transaction.

Those transactions are made up from a thousand different reasons from folks using their bank cards in another country, to businesses paying foreign currency invoices, to other hedging future transactions. If you really think about the size of commerce FX moves, it’s huge and makes up a giant share of the market. Pretty much most banks business is filling client orders, which is vast.

So, what’s just happened? A huge chunk of the world’s commerce has been shut down in a matter of weeks. Air travel is down over 80% and whole industries are shut down. The natural everyday flows of money have ground to a halt. That’s an unthinkable amount of liquidity suddenly gone from the market, and it’s going to cause liquidity issues, like we’ve seen perhaps today with AUD spiking 130 pips on nothing. It means less money (smaller orders) is going to push prices further than normal because there’s less on the other side to soak it up.

Here’s another thought. Was it this drop in global FX movements that caused the USD shortage? The majority of business conducted globally is in USD, so if suddenly the back and forth flows of USD stop, certain parties find they’re suddenly not receiving the dollars they need to pass on elsewhere. If the chain stops at one point it reverberates down the line. All FX markets do, via banks, CB’s, governments and whoever else, is constantly push money around the globe. Peter pays Paul, Paul pays Dave, Dave pays Sandra, Sandra pays Peter. Round and round it goes, yet if one of those people stop paying, the whole thing breaks down. Then Paul has to borrow USD off Sandra to pay Dave, Sandra borrows from Steve to pay Peter…  Then suddenly Dave stops paying…. Then no one has USD to lend or borrow….you get the picture.

These are unprecedented times and it’s at times like this that we all realise that we don’t really understand markets at all. Over the GFC the liquidity problem was one of debt and that everyone realised they owed everyone else, were overleveraged and they couldn’t pay. This crisis is different because (supposedly) safeguards were put in place to stop overleveraging and bad debts building up into a crisis but in this case, the money is all there but it has just stopped moving.

This may or may not be the answer, and no one is ever going to really know. For our trading though, we have to realise and accept that liquidity is much lower (that’s been confirmed by people we speak to in the market) irrespective of the reasons why. The reasons don’t really matter, what does is how we trade it and manage our risk. We have to adjust to the conditions in front of us, and that can be hard for some.

A final note.

The last few weeks has been a real rollercoaster and it’s been hard to keep our site updated while we’re all busy trading, so I want to apologise for that. What I will say though is that being in a community has been a real help to find our way through these markets. Speaking to others with calm heads and sensible thinking through all the volatile moves has certainly helped get me through this. And that isn’t just about making money, it’s also about not losing money. Knowing the conditions, the likely flows, identifying the reasons why a price is moving right at that minute enables us to make sounder judgements. And, through all the volatility, the big opportunities have been indentified and traded.

If you’re struggling to make sense of the markets, or have hit a rough patch and don’t know how to dig yourself out of it, think about joining a community of traders who are just like you and have some experienced heads to help guide you. You’re welcome to join ours.

Ryan Littlestone
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