Forex trading is a promising money-making venue that attracts many traders. It’s highly liquid, volatile, and easy to learn. But can the forex market ever crash?
The forex market can never crash because it runs on currencies which are the backbones of economies. Without them, the global economy will crash. Plus, central banks dominate this market, preventing it from crashing. However, individual currencies may crash due to political or economic reasons.
Read on to see why forex can never crash and why currencies may crash, as well as their consequences. You’ll also learn about various kinds of currency crashes and the differences between forex and stock market crashes.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
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Why Doesn’t Forex Crash?
Most new traders in forex may wonder if it ever crashes like other financial markets such as stocks. Forex is clearly the largest financial market today. The second-largest financial market is the stocks market, with much less value in terms of daily trades.
It seems impossible for a market with $6.1 trillion transactions a day to ever crash. And it’s never going to crash due to its sheer size and many other reasons. That’s why investors can plan their long-term trading in the forex market. One of the most important reasons why forex never crashes is that it runs on currency pairs. Currencies are the foundations of any country’s economy that affect the world on many levels. Currencies drive most daily interactions.
Economies can’t work without them since they’re an indispensable part of financial systems. On the global level, currencies are connected due to the exports and imports among different countries. Exchange rates affect our daily lives since we need them to buy services and goods from other countries.
So, the forex market will never crash because it revolves around the foundation of economies.
Another reason explaining the forex market’s strength is those who use it. Unlike the stock market that private and corporate players govern, central banks and major commercial banks in the world dominate the forex market. These banks engage in billions of dollars’ worth of trades every day to ensure the global and local economies remain stable.
While retail traders look to profit in forex, central banks stabilize economies and currency values in this market. Without the activities in forex, currencies would fluctuate aggressively, making economies unstable.
The other market participants also contribute to its ever-expanding dominance. Since forex is accessible for everyone, highly profitable, and easy to trade, more and more people get interested in it, making it even more difficult to crash.
Currencies Can Crash in Forex
While the forex markets can’t crash as a whole, individual currencies may face crashes from time to time. Interestingly, since currencies are traded in pairs, a currency will rally when the other one crashes.
Currencies that crash experienced a considerable drop in their values due to political or economic shocks. Naturally, the traders that hold the crashed currency will lose a significant part of their investment, while investors holding the other currency will gain massive profits.
That’s why a crash in one currency can’t lead to the whole market’s crash even if many currency pairs include the crashed currency. On the contrary, it leads to other currencies gaining power, benefiting the whole market.
Two types of currency crashes exist: long-term crashes that last for several months or even years and flash crashes that last less than an hour. These crashes both cause significant losses for investors, even leading to whole accounts’ wipe-out.
Long-Term Crashes
Long-term currency crashes usually happen due to a country’s socio-economic conditions, such as hyperinflation or political unrest. That’s why they last for a long time.
Most developing countries suffer from long-term currency crashes due to weak economies and infrastructures that drive away foreign investors, negatively affecting the economy.
Flash Crashes
Flash crashes are more dangerous than the long-term crash since they’re unexpected, and people who hold that currency pair can’t predict the crash. Plus, they can happen due to no apparent reasons, making them even riskier.
One of the most famous and recent flash crashes is the yen’s crash in 2019 during a Japanese bank holiday. It lasted for 8 minutes, bringing down the yen’s value by five percent and rallying the US dollar eight times. Since it was a major base currency, many other currencies paired with the yen were also affected. Some traders experienced significant losses/gains due to this crash, and many had their accounts wiped out.
According to experts, the crash happened due to the low liquidity between 17:00-18:00 NYT, known as the witching hour, when the Japanese markets were still closed. Another reason was the announcement of weak revenues by Apple Inc., which probably scared investors and triggered the flash crash.
Another cause of a flash crash happened a month after the yen crash when the swiss franc dropped in value. Experts attributed this mini-crash to low liquidity because Japanese markets were closed during the National Foundation Day celebrations.
Swiss franc caused another crash in 2015, which provoked it to go up in value and crash its pairing currencies. The Swiss National Bank announced it would unpeg the franc against the euro at 1.20. As a result, the franc’s value increased by 20% against many major currencies, including the euro.
Differences Between Forex and Stock Market Crashes
Crashes in the stock market are completely different from those in forex. While the forex crashes affect specific currencies, the stock market crashes affect most stocks traded in similar currencies. A crash in one stock creates a domino effect that causes other stock markets and indices to crash.
When a major index like Dow Jones drops by over 10%, a stock market crash occurs. It could affect the whole market, including several sectors and industries. The most important reason leading to the spread of crashes across the whole market is panic among investors, making them sell more and cause the market to go down.Since most markets are closely related across the world, a crash in one market could affect others, too.
The most recent stock market crash occurred in 2008 due to the economic recession. On September 29, 2008, the Dow Jones Industrial Average lost 778 points, the world’s largest point drop within a day. It was about 8 percent of its value, followed by an additional drop by 8% a few days later.
How Can Investors Predict Currency Crashes?
While it is not possible to predict currency crashes all the time, investors can avoid risky investments by tracking all political developments and staying on top of the news. Most forex investors take positions on major base currencies that are more stable than others.
Specific financial institutions and banks are always watching the forex market, preventing or fixing major market problems. For example, the Federal Reserve in the US is probably one of the most influential authorities that control global monetary policies. Investors can predict potential market developments by closely watching what the federal reserve does in monetary policies.
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Conclusion
Forex is by far the most powerful financial market in the world. Forex can never crash, unlike the stock market, because it involves the most crucial economic component: currencies. Besides, since central banks and major financial institutions dominate the market, they won’t allow it to crash.
However, currencies can lose their values due to political, geopolitical, social, or economic reasons. The big crash of the yen in 2015 is a classic example that causes many traders to lose their capital.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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