introduction
The entire forex market cannot collapse, but some currencies can collapse at any time. The sharp declines in the currency markets differ from those we see in the stock markets in that the fall in the currency market usually affects a specific currency and not all currencies combined. For example, when the Swiss central bank decided to unlink the franc from the euro, the Swiss currency took a plunge and the rest of the currencies took their course in what is now known as a temporary collapse or flash crash. The same scenario was repeated with the Japanese yen in early 2019, when the currency rose sharply in a matter of moments and the rest of the currencies fell as well.
The difference between the stock market crashes and the forex market
Stock market crashes differ from those we see in the forex market in that the stock market crash usually affects most stocks since they are all traded in the same currency. For example, the collapse of the S&P 500 index, as is true of all stock markets and other indices, often results in sharp price declines for the majority of the stocks of the companies included in that index.
On the contrary, the collapse of the currency markets usually affects a currency, such as the British pound or the US dollar, and usually occurs due to unexpected events that shock investors and make them want to sell the currency in question as quickly as possible. However, forex trades usually involve two currencies, such as the GBP/USD pair, ie the British pound against the US dollar, meaning that the dollar will rise while the pound falls.
Based on this scenario, while the buyers of the pound will suffer sharp falls in the value of their positions during the aforementioned crash phase, those sitting on the other side of the deal will reap huge profits after benefiting from the US dollar’s rise have the pound sterling.
The same scenario applies to any other currency that could suffer a collapse, as its counterpart’s currencies will post strong gains as that currency’s value erodes in the forex market.
The fact that the forex market includes a large number of currencies, each representing a different country and region, means that since each currency is traded in a pair against another currency, it is impossible for the entire market to collapse . and therefore the corresponding currency will benefit from the collapse of the other currency.
What Causes Currency Crashes
Now that we have established that the forex market as a whole cannot collapse overnight, although some currencies can experience sharp declines individually from time to time, let’s take a look at the most prominent instances of collapses that forex markets have experienced in the past Years. Let us first remind you that there are two main types of price declines, the first being the long-term declines and the other being the intraday declines. Long-term declines typically last months, possibly years, while intraday crashes occur within seconds and typically last no more than an hour.
Irrespective of the nature of the drop, investors in the respective currency suffer enormous losses, which can sometimes lead to the destruction of their entire accounts.
Currency collapse in the long term
The long-term collapse of a currency is often related to the prevailing social and economic conditions in the country in question and therefore usually lasts for long periods of time. These cases of currency collapse mostly occur when the country in question is facing a major crisis, such as B. a military coup, runaway inflation rates or other major economic challenges.
For example, Venezuela’s currency is in deep crisis as the value of the bolivar has plummeted in the wake of US sanctions, mainly aimed at the country’s oil industry, which is Venezuela’s main source of foreign exchange.
The ruling regime in Caracas is also controlled by an authoritarian government isolated from the international community, which has severely damaged its economy. This is one of the most prominent examples of a long-term currency crisis that takes many years to resolve.
Nonetheless, these types of long-term currency crises often occur in developing countries that lack strong institutions, and in the meMost cases are managed by authoritarian rulers who employ populist policies that fail to please investors, which ultimately negatively affects the country’s economy and can lead to its collapse. .
Beware of momentary crashes
Forex traders were shocked by the intraday and sudden collapse of the Japanese yen on January 2nd, 2019, when the Japanese currency appreciated by 3-5% against other currencies like the US dollar in just eight minutes.
This sudden jump caused traders who had open positions in the Japanese Yen to suffer huge gains/losses. This jump in price not only lasted for a short time but caused severe damage to most traders as it led to the activation of stop-loss orders in their short deals, which in some cases resulted in zero accounts for some people within minutes.
Most currency analysts attributed this sudden jump to automated trading systems, especially given the lack of extraordinary economic or political events that could explain this resounding collapse, which took place during a week-long holiday for Japanese banks.
