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Three signs of market chaos

  • By ForexTime

     

     

    Three signs of market chaos

     

    Professional forex traders are well aware of the risks involved in trading currencies and the events of the last few years have only heightened that awareness. We all remember the carnage of 2008 and the volatility that was seen across nearly every asset class available.

     

    However, while risk is always at the forefront of a traders mind, the fact is that markets actually trade in a very sensible and organised fashion for the majority of the time. The trouble is, that those few days/ weeks of volatility, can be so severe that they can destroy months of hard work in a very short space of time.

     

    With that in mind, it's important for traders to choose a reputable broker, such as FXTM, to approach markets with confidence, but to always be on the lookout for signs of chaos.

     

    Yield curve

     

    The yield curve measures the difference between the 2-year US Treasury rate and the 10-year Treasury rate and has come to be an excellent indicator of financial stress and recession.

     

    In normal conditions, the 10-year Treasury should offer investors a higher yield, since traders should be compensated more for being invested for a longer period. Conversely, short term rates should offer lower yields as investors are putting their money at risk for a shorter period of time.

     

    Sometimes, however, 10-year yields drop as traders determine that it is safer to invest in the longer term rates than in the short term. This causes the yield curve to flatten or even invert. It's therefore a significant indicator of increasing risk and turmoil in the markets.

     

    TED spread

     

    The TED spread does a very similar thing but it measures the difference between US Treasuries and the Eurodollar rate. The Eurodollar is a very short term, highly liquid money market, considered to be one of the safest and lowest yielding investments available. It's the kind of market that the major banks use to fund their operations.

     

    However, in times of stress, such as in 2008, the TED spread widens, as the safety of Treasuries wane, compared to the Eurodollar. It's another sign of turmoil and an indicator that safe haven currencies might be the best play.

     

    Unexpected announcements

     

    Unexpected announcements can often precede the beginning of big moves in the financial markets; an investment bank that suddenly announces it is in financial trouble, a surprise interest rate cut from a central bank or a European bond auction gone wrong, there are many catalysts that can lead to market turmoil.

     

    The key for traders is to recognise that catalysts like these are clues to the health of the financial system. The buildup of several small events can be just as troubling as one large event by itself.


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