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Risk aversion in the forex market

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I often hear newcomers in the forum asking ” The news was bad for the US! Why did the USD strengthen? I had a margin call

I feel sad when i see this as after all , money is not easy to come and losing it at forex is not the best way to spend it.

To explain the above, allow me to touch in simple terms one of the theories with regards to the above.

Risk Aversion.

In all markets, sentiments are the reason behind all movement.

You feel good about A, you buy.

You feel bad about B, you sell.

1) Prior to the current crisis, say before 2008, markets were doing good. Properties, equities.

Everyone felt ready to take risk and invested all over the world.

Everyone was risk seeking.

2) When the market began it’s spiral downwards in the mid of 2008, everyone paused to look at one’s own risk taking and exposure.

“Hmm, the market is collapsing. Are my money in danger? i better shift my funds out when i can and park them in safe assets in the meanwhile”

What are some of the relatively safe assets in the world?

  • Gold
  • US government treasury bonds
    ( The US government won’t go bankrupt right? )

These are in USD and hence currencies are being exchanged for USD.

USD strengthens.

Everyone was risk averse.

This apparently still happens now on a smaller scale when negative developments occurs in the markets.

Let’s bring an example in for better understanding.

Find below a chart comparing the MSCI World index of equities in developed countries ( Yellow ) and the US Dollar Index ( Green ) from OCT 07 to today.

I have divided into 3 sections.

Section 1 were the days before the crisis. You can see the World index climbing steadily while the USD weakens steadily. ( Note that the beginning of 2008 has marked problems for the World Index but perhaps folks have not went into risk averse mode )

Section 2 was when the crisis started to unfold. You will notice a sharp drop in the World index while the USD gains in strength. Apparently folks were liquidating their positions all over the world, seeking safe assets.

Section 3 marks the “recovery” phrase. The World Index once again climbs and the USD weakens.

I hope this was of help and the next time a negative US news is released and the USD strengthens, i hope you are not caught off guard.

Folks, i wish to reiterate that forex trading is not an easy “game”. You have to practice proper money management while trading and catch up with developments in the world.

Trade safely please and i hope to see you around.


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