The foreign exchange (forex) market has seen a remarkable resurgence in 2022, with increased volatility leading to opportunities for traders. After a relatively calm 2021, forex pairs have shown sizeable swings this year as uncertainty around interest rates, inflation, and geopolitics shake up currency valuations. For seasoned forex traders, these are the market conditions where profits are made.
In this comprehensive guide, we’ll break down what’s causing the forex rally in 2022, strategies to capitalize on it, and how to manage the risks inherent in trading major currency pairs exhibiting large price swings. Whether you’re a novice looking to get started in forex trading or an experienced trader seeking new opportunities, read on to uncover everything you need to know about the current comeback in the foreign exchange market.
What’s Causing the Forex Rally?
Forex markets tend to experience increased volatility during periods of economic or political uncertainty as traders react to changing conditions that affect currency valuations. Here are some of the key factors contributing to forex market volatility:
Diverging Interest Rates and Central Bank Policy
With inflation running hot, central banks have been hiking interest rates aggressively in 2022. However, the pace and magnitude of rate hikes varies between regions. For instance, the U.S. Federal Reserve has raised rates faster than the European Central Bank. These diverging monetary policies affect currency valuations and lead to big swings in forex pairs like EUR/USD.
Geopolitical Tensions
Events like Russia’s invasion of Ukraine inject uncertainty and spur dramatic short-term moves in currencies like the Russian ruble. Even non-combatant currencies are impacted by factors like economic sanctions. Geopolitics is likely to remain a volatility driver.
Concerns Over a Global Recession
As central banks tighten policy to curb inflation, fears of an ensuing recession continue to grow. This fundamental concern results in shifting risk appetite among forex traders. In a recession, safe haven currencies like USD, JPY and CHF tend to appreciate.
Supply Chain Issues and Commodity Price Shocks
From energy prices to food costs, the Russia-Ukina war and ongoing supply chain disruptions have caused immense volatility in commodity markets. Currencies of major commodity exporters like Canada and Australia have been impacted as prices of crude, grains, metals and other raw materials fluctuate.
These are just some of the macro factors causing turbulence in foreign exchange markets this year. Next, let’s look at trading strategies tailored to capitalizing on rallying forex pairs.
Strategies to Trade a Forex Rally
When forex pairs experience big rallies, it creates opportunities for short-term trades aiming to profit from the momentum. Here are some strategies suitable for market conditions in 2022:
Breakout Trading
Volatile markets like today’s are conducive for breakout strategies. This involves identifying horizontal support and resistance levels, and buying or selling when the pair breaks out of the trading range. Rallies often lead to strong breakouts.
Trend Trading
In a sustained rally, forex pairs demonstrate a directional bias forming an uptrend. Trend traders aim to get in early and ride the trend. Useful indicators for identifying and trading trends include the moving average convergence divergence (MACD) and the average directional index (ADX).
Range Trading
While forex pairs move directionally during rallies, they often pause to consolidate forming trading ranges during pullbacks. Skilled traders can sell at range resistance and buy at range support. The key is waiting for clean breaks versus false breakouts.
News Trading
Scheduled event risk like central bank meetings, economic data releases, and elections result in short-term volatility as the forex market reacts. Being nimble around news events allows traders to capitalize on spikes in volatility.
Scalping
This very short-term strategy involves opening and closing trades within minutes to capture small profits. Scalping is suited for rallies as it allows traders to benefit from the increased pip swings. Support and resistance levels can act as exit points.
The abundance of price action makes rallies well-suited for momentum and breakout strategies. However, ranges and pullbacks also emerge, creating chances to buy low and sell high. Overall, forex rallies enable traders to employ an array of strategies.
Key Currency Pairs to Watch
While all major and minor forex pairs demonstrate heightened volatility during rallies, some tend to exhibit larger swings. Based on current market drivers, here are some of the best currency pairs to trade right now:
EUR/USD
The world’s most heavily traded currency pair continues to be a top market mover in 2022. With ECB lagging the Fed in rate hikes, EUR/USD has trended lower but also shown large bounces on shifts in risk sentiment. The wide daily ranges suit short-term traders.
GBP/USD
With the Bank of England also hiking rates, Cable has seen large moves tracking changing outlooks on the UK economy. The Ukraine war’s impact on UK inflation has been a driver. GBP/USD offers opportunities on both trend and range setups.
USD/JPY
This safe haven pair has rallied sharply with yields rising faster in the U.S. compared to Japan. The Bank of Japan remains dovish, while the Fed is firmly hawkish. USD/JPY breakouts have been explosive recently.
AUD/USD
The Aussie is vulnerable to declining global growth prospects but also benefits from rising commodity prices. The shifting dynamics have resulted in expansive daily ranges. AUD/USD is ideal for short-term trades.
USD/CAD
Like its “Aussie” counterpart, USD/CAD faces countervailing forces from growth fears and commodity gains. Canada’s relatively hawkish central bank is also impactful. The daily range has frequently stretched beyond 100 pips.
The most active forex pairs with the highest liquidity tend to provide the most trading opportunities during rallies. Focus on a few currency pairs and learn their technical patterns.
Managing Risks of Volatile Markets
While a forex rally opens doors for profits, the increased volatility also elevates risks if not managed properly. Here are some tips for trading actively but also controlling risks:
Use Stop Losses
Volatile markets mean prices can quickly move against you. Always use stop losses to limit downside on every open trade. Adjust stops to lock in some partial profits as the trade moves favorably.
Size Positions Appropriately
Leverage gives flexibility but also amplifies losses if used recklessly. Size positions according to your risk appetite and account balance. Don’t risk more than 1-2% of capital per trade.
Trade Smaller Lot Sizes
Consider lowering your standard lot sizes to cut exposure in volatile conditions. Trading micro or even nano lots can equate to less risk per pip movement.
Limit Daily Losses
Define a daily loss limit and cease trading once you reach it. This prevents volatility from quickly wiping out your account. Re-evaluate trading plans during times of heightened volatility.
Avoid Overtrading
Overtrading frequently does more harm than good. Show restraint and stick to the best setups rather than actively seeking trades due to FOMO. Less is often more.
Volatility is a double-edged sword. While it creates profit potential, risk management is crucial to long-term trading success. Apply prudent risk and money management tailored to market conditions.
Looking Ahead at the Forex Market Rally
Forex traders should expect continued volatility for the remainder of 2022 and potentially beyond. Major macro themes driving price action are likely to persist, including changing central bank policies, geopolitics, recession worries, and commodity price volatility.
Traders need to think on their feet and adapt strategies to capitalize on both trending and ranging markets. Success requires balancing prudent risk practices with the flexibility to react. As long as uncertainty exists, forex will offer tremendous trading opportunities.
The current forex rally provides the ideal environment for active traders to generate profits. Use this guide to understand the forces driving the comeback, employ suitable strategies, focus on active currency pairs, and manage risk effectively. Harness the potential while navigating the pitfalls to trade forex successfully in these lucrative yet turbulent times.
