Lets be honest whichever way we look at it, the economy is in trouble and the current outlook looks bleak, so can a trader take advantage?
When the market starts to fall, some investors start to panic. Others start to take action because there are many ways to take advantage of downward markets. If you learn how to trade falling prices you will earn.
If you are trading forex via CFDs you are trading price movement, so if you trade in the right direction you benefit, up or down, it makes no difference as long as you are correct.
So how to take advantage of falling asset prices? Short.
Perhaps the most common way of profiting when a market declines, is short-selling. There are a variety of ways that an individual can short-sell, depending on which market you want to trade and the product you want to use.
1. Buy Safe-Haven Assets
A safe-haven asset is a financial instrument that typically retains its value – or even increases in value – while the broader market declines. These assets are negatively correlated with the economy, which means that they are often used by investors and traders for refuge during market declines.
In theory, you would take a long position on a safe haven, in order to prepare for market downturns. This is seen as an alternative to closing positions or going short, as it enables you to hedge any existing holdings.
Common examples of safe-haven assets include gold, government bonds, the US dollar, the Japanese yen and Swiss Franc.
If we take the example of gold, to invest in the safe-haven asset, you’d be looking to buy the physical precious metal as a store of value. However, if you were just looking to speculate on the value of safe havens, you could use derivative products so that you didn’t need to take delivery of the asset itself.
Gold is perhaps the most commonly perceived safe haven investment. The price of gold has a negative correlation with the stock market, meaning that in a stock market crash, the price of gold will most likely soar. It can also act as a form of insurance, as investors sometimes reallocate assets from their portfolio into the gold market.
Gold trading is a popular strategy for hedging, given that its value has remained constant for many years. In a hedging strategy, traders attempt to balance their potential losses from existing positions by introducing gold into their portfolio.
2. Back Other Precious Metals
Although most investors will immediately think of gold as a safe haven commodity, some are slowly starting to consider other precious metals such as silver and palladium with the same status. In fact, the price of palladium has increased over recent years to become more expensive than gold, which could suggest that this precious metal may share the same safe haven value within the market in the future.
3. Trade Safe-Haven Currencies
The U.S. dollar (USD), along with the Japanese yen (JPY) and Swiss franc (CHF) are considered safe-haven currencies.
When there’s a lot of uncertainty in the world. there is usually a “flight to safety” to one or all of these currencies.
A safe haven currency tends to strengthen when risk assets sell-off.
There are currencies that are commonly used as safe havens during periods of financial decline, but this is just one way in which to use the forex market as a hedge against a market downturn.
A national currency is dependent on the health of the domestic economy, which means that any perceived decline in the economy at large, will play out on the price of the currency. If an economy is seen as weaker than other global economies, its currency will depreciate compared to other global currencies. For example, during Brexit negotiations, the political turmoil and instability impacted the appeal of investing in the UK. This saw volatility play out across the FTSE 100 and British pound sterling.
Traders can take a position on the price of a declining economy by opting to short a currency. When you trade forex, you’re inherently buying one currency and selling another. For example, when you sell GBP/USD, you would do so if you believe the value of the pound will fall in comparison to the US dollar.
What are the best safe haven investments?
It is not possible to categorically state what the best safe haven assets are because they will change depending on the economic environment. So, research into the state of the market is needed to assess which instruments might offer the greatest security.
A common strategy is to diversify across a range of safe haven assets, to essentially hedge your bets on which one will provide the strongest protection.
4. Financial hedging
Hedging is the practice of opening positions in order to protect your portfolio from volatility or uncertainty within the financial markets. This involves offsetting losses on one position with gains from the other.
Typically, the aim of financial hedging is to take a position on two different financial instruments that have an opposing correlation with each other. This means that if one instrument declines in value, the other is likely to increase, which can help to offset any risk from the declining position with a profit. These investment decisions should not be rushed and require a lot of thought and analysis beforehand.
Financial hedging is perhaps more common amongst short-term and medium-term traders, as market volatility tends to last for limited periods of time and these traders aim to take advantage of rapid price fluctuations. Long-term position traders are less likely to take into account recent changes within the market and instead, they more often open positions based on their predictions for the long-term future.
Hedging strategies are commonly used by retail traders that have a good knowledge of the financial markets and are able to forecast upcoming changes within the economy. However, anyone can use a hedging strategy, especially if there is a large sum of money or portfolio involved. For this reason, professional traders and institutional investors also tend to apply this strategy.
To summarise, the markets will often enter a downturn and therefore we must be prepared to amend our strategies accordingly. An astute trader looks at every opportunity.
Safe haven assets react specifically to economic downturns, so choosing the correct asset and strategy will give a trader a great chance of earning even during a downturn.