Trading Forex in Bull and Bear Markets

TRADING FOREX IN BULL AND BEAR MARKETS

 

Bulls and Bears; what are they on the stock markets and how do they affect forex trading? They are common terms used in financial markets to describe the price movements of the market and overall market sentiment. Bull and Bear signals are a vital element of forex trading analysis.

Basically, a Bull market is when prices of securities and commodities are rising and a Bear market is when prices are heading down. Markets described as bullish reflect optimism and confidence with a high expectation of good trading conditions and investment opportunities. Bearish markets reflect pessimism, declining confidence and lower expectations of profitable investment opportunities.

Bull and Bear markets influence forex traders’ expectations of the rise and fall of exchange rates and the strength and weakness of currency pairs. In order to make profits on price movements, forex traders closely watch for bullish and bearish trends. This helps them decide whether to stick to hard, safe-haven currencies or expand their portfolio to include soft, riskier currencies.

 

Did you know?

One way to remember the difference between a Bull and Bear market is to think about how each animal attacks its prey. A Bull thrusts its horns up into the air; metaphorically representing a dramatic upswing in stocks. A Bear swipes down on its prey and batters it to the ground; metaphorically representing a downswing in stocks.

 

What causes a Bull market?

 

Factors that contribute to a Bull market include:

  • country has a strong economy with high GDP; indicates consumer spending is high
  • unemployment is low; business growth leads to growth in workplace
  • inflation is under control; consumer prices are stable
  • rising stock prices across all assets; positive market sentiment and aggressive buying
  • more ‘long stock’ trading takes place; confidence that economic growth is sustainable

 

A Bull market occurs when there is a notable and aggressive upwards price movement over a period of time. This could be weeks, months or years. Typically, the average length of a Bull market is about 5 to 8 years. A market that has traded sharply higher by at least 20 percent is considered a Bull market.

In a Bull market, stocks go up in price and investors feel bullish (optimistic) because they expect security and commodity prices to continue to rise on the back of a bullish market and they anticipate selling high in the future.

The main characteristic of a Bull market is there are more buyers than sellers and when demand for assets increase across the board, prices go up.

A Bull trader buys securities or commodities in expectation that market prices will continue to rise. A Bull trader’s actions in turn make a market more bullish because demand drives up rising market prices.

 

What causes a Bear market?

 

Factors that contribute to a Bear market include:

  • country’s economy is showing signs of declining with weak GDP; indicates consumer spending is low
  • unemployment is high; slow or declining business growth leads to retrenchments in the workplace
  • inflation is growing; consumer prices are increasing
  • stock prices falling across all assets; negative market sentiment and aggressive selling
  • less ‘long stock’ trading takes place; lack of confidence in the economy and stock prices

 

A Bear market occurs when there is a notable and consistent downturn in the market. The market moves from Bull to Bear when securities and commodity prices have fallen at least 20 percent from previous highs. A Bear market can last anything from a few weeks to several years depending on contributing factors.

The main characteristic of a Bear market is there are more sellers than buyers and when demand for assets decrease across the board, prices go down.

A Bear trader starts to sell securities or commodities in expectation that market prices will continue to fall. A Bear trader’s actions in turn make a market more bearish because lack of demand for securities and commodities drive market prices down.

 

When Bulls become Bears and vice-versa

 

Forex is traded in currency pairs. Traders take advantage of the rise and fall of markets, typically choosing a currency pair where one currency is weakening and one is strengthening.

Fundamental and technical analysis allows forex traders to identify price movements and market sentiment and it helps them manage risks accordingly. A good understanding of Bull and Bear markets goes a long way in helping beginner traders know when to prudently enter and exit trades.

A Bull market can become bearish if negative news on a country, its economy and falling stock prices increases. It also turns bearish when it moves into an overbought zone. This is when a security is believed to be trading at a level above its intrinsic value.

A Bear market can become bullish when news is more optimistic and market sentiment improves. It may become bullish after it has moved into the oversold zone and current prices don’t suit sellers.

 

Did you know?

A Bull market is a rally greater than 20%, but only becomes official when the S&P 500 hits a record closing high. A Bear market is defined on Wall Street as a 20% decline in the S&P 500 from close to close. It’s only officially over when the market recovers back to a new closing high.

Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices

 

Trading hard and soft currencies in Bull and Bear markets?

 

It’s not necessarily prudent to sell when the prices of securities and commodities are going down. Often, that’s the best time to be a buyer. Likewise, when the market is going up, it’s often a good time to sell.

Experienced traders know how to take advantage of Bulls and Bears signals. They usually do exactly the opposite of what the rest of the investors are doing which might be panic buying or selling.

Remember, volatility in the forex market is good if you know what you’re doing. It’s bad if you don’t. Volatility increases the risk of forex trading but it also presents great opportunities to make profits.

Let’s look at which currency pairs come out tops in Bull and Bear markets. Keep a close eye on the political and economic fundamentals and make use of technical analysis tools to successfully trade through rough and calm waters.

 

What is a hard currency?

 

A hard currency is also known as a safe-haven currency. These currencies are expected to retain their value or increase in value during volatile trading conditions. Safe-haven currencies are sought after by forex traders and investors – particularly beginner traders – in order to limit their exposure to risk and losses if the market becomes bullish.

The US Dollar (USD), Euro (EUR), Japanese Yen (JPY) and Swiss Franc (CHF) are examples of safe-haven currencies. They are considered safe because they are consistently more reliable and stable and offer protection during market downturns. However, there is no guarantee that safe-haven currencies will hold their value during times of high volatility.

Safe-haven currencies usually strengthen in a Bear market. This is because they are highly liquid, meaning they are in demand and can be sold off easily. Safe-haven currencies such as the USD and JPY increase in demand in volatile trading conditions because forex traders tend to offload riskier instruments first.

Safe-haven currencies can lose their value in a Bull market because forex traders and investors often expand their portfolio and take positions on soft currencies or riskier financial instruments when feeling bullish.

 

What is a soft currency?

 

Soft currencies struggle to hold their value or increase in value in volatile market conditions. They’re often referred to as ‘weak currencies’ because they tend to be unstable and less reliable than hard currencies.

Currencies from most emerging or developing countries are regarded as soft currencies. Examples of soft currencies include the Australian Dollar (AUD), Canadian Dollar (CAD) and New Zealand Dollar (NZD) as well as emerging market currencies such as the South African Rand (ZAR) and the BRIC currencies (Brazil, Russia, India and China).

Their value is often misaligned because developing countries typically set unrealistically high exchange rates and peg their currencies to hard currencies like the USD. The value of soft currencies can fluctuate wildly in a Bear market as they are vulnerable to political and economic strife or uncertainty.

Soft currencies can do well in a Bull market. If forex traders and investors feel bullish, they’re often inclined to expand their portfolios and take a punt on less stable or reliable currencies.

 

What do forex traders do in a Bull market?

 

In a Bull market, confidence in stocks improves and investors are more willing to invest in securities and commodities. High demand drives up prices. Forex traders enter trades as prices start rising and sell when they believe a bullish trend is reaching or has reached its peak. Typically, Bull forex traders buy lower to sell higher in the future.

Furthermore, forex traders tend to open more long positions when the market becomes bullish. This in itself increases demand and prices of financial instruments rise further.

 

What do forex traders do in a Bear market?

 

In a Bear market, a country’s economy is struggling and investor confidence is low. GDP is weak, inflation is rising and unemployment is high.

Stock prices are taking a hammering under the constant barrage of negative news and economic reports and prices start falling. Investors are spooked and start offloading securities and commodities, especially those deemed more risky.

Forex traders need nerves of steel in a bearish market, particularly if they can’t foresee how long the downward pricing trend will continue. Trading forex in a Bear market is risky and can be intimidating for new forex traders.

Prices are trending downwards and market confidence is low. However, it’s possible to make a profit in a Bear market but you need to adapt your trading strategy accordingly. This might involve taking long positions in the hope you’ll ride out the bearish storm and profit when it becomes bullish.

 

How to identify Bull and Bear markets

 

Forex traders use an array of technical analysis tools to gauge market sentiment and to anticipate currency behaviour when markets are transitioning from Bulls to Bears, and vice versa.

The two most common technical analysis tools for identifying Bull and Bear markets are price charts and the Moving Average (MA).

 

Forex price charts

 

Price charts are a graphic tool that shows the historic behaviour of the relative price movement of currency pairs in different time frames. Basically, forex traders rely on past behaviour to predict future price movements.

The most common forex charts are line, bar and candlestick charts. The time frames range from tick data to hourly, monthly and yearly data. A tick in forex tick charts denotes the change in price of a currency pair which was caused by a single trade.

When a currency price is trending upward; each subsequent maximum is higher than the previous one and each subsequent minimum is higher than the previous one.

 

Moving Average (MA)

 

The two most common Moving Average (MA) tools form the foundation of technical analysis and a trader’s forex trading strategy.

  • Simple Moving Average (SMA) is the average price over a given number of time periods
  • Exponential Moving Average (EMA) gives more weight to recent prices

The Moving Average (MA) is one of the best ways to determine if a market is bullish or bearish. The MA is represented in the form of a curve which changes according to the direction of the trade. Forex traders typically use a combination of MAs, usually the 50-day MA and 200-day MA.

A Bull signal is raised when the price moves above the curve. A Bear signal occurs when the price moves below the curve. The trend is likely to reverse when the price crosses the curve. The potential direction and strength of the price movements in the forex market are reflected in the angle of the slope of the curve.

 

FTA DISCLAIMER

Trading foreign exchange on margin carries a high level of risk and may not be suitable for all investors. Forex trading involves a high degree of leverage which increases the risk associated with forex trading.

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