Betsy Walters, global director of dbFX, takes a look at the impact the recent financial turmoil has had on foreign exchange trading.

The past few weeks have been some of the most challenging I have seen in my 25 years working on Wall Street.  Not surprisingly, the bad news and volatility that has been occurring in the credit and financial markets has also spilt into the foreign exchange (forex) markets, and we’re seeing significant volatility across currency pairs, particularly where the US dollar is involved.

Here’s proof. Looking at the daily price movement in EUR/USD from 5pm one day to 5pm the following day, New York time, we have, over a number of years, calculated the average daily price moment of the currency pair in a day. Until this month, the highest price movement differential was 1.55 per cent, reached in September 2000.

On average, the daily movement in price of the EUR/USD tends to average one per cent a day, but in the past few years we have had less volatility, with narrower daily movements. In 2005, it was as low as 0.87 per cent, in 2006 it was 0.73 per cent, in 2007 it was 0.60 per cent and in the current year to date it has been 0.98 per cent. 

However, looking at September, the average has significantly increased to 1.67 per cent (as at the end of September 2008), and was up even more to 1.88 per cent as of 13 October, a marked difference from its average, and a reflection of the high volatility in the forex market currently. 

But of course, with greater volatility come better trading opportunities. Not only does volatility create wider spreads, but also more spikes in the market, enabling investors to make a decision on the future direction of a currency pair. 

It also means higher risk, which makes it more important than ever to be well prepared before you start trading. For example, when you enter a trade you should have pre-set expectations for where you think the market will go (profit levels) and where you will get out if you are wrong (stop-loss).

The extreme conditions in the credit markets are creating an inverted yield curve (where short-term rates are higher than long-term rates) in the US for the first time since the 1970s. From a forex perspective, this means you will see massive swings in the day-to-day roll rates on your trades. The ‘daily roll rate’ is the interest rate you earn or pay each day when you hold a currency overnight. 

In short, volatility brings market movements, which brings the opportunity not only for returns, but for losses as well. So it’s vitally important that you plan your trades carefully and understand the impact the activity in the wider market is having on the forex market. 

Forewarned is fore-armed, after all.  

For more information on currency trading, visit www.dbfx.com