Could the forex market collapse?
The short answer to this question is "yes" and "no". The entire forex market cannot collapse, but some currencies may collapse at any time. The sharp declines in the currency markets are different from those we might see in the stock markets, in the sense that falling prices in the forex market usually affect a particular currency, not all currencies combined. For example, when the Swiss central bank decided to disengage the franc and the euro, the Swiss currency jumped, and the rest of the other currencies took their course, in what is now known as a momentary collapse or flash crash. The same scenario was repeated with the Japanese yen at the beginning of 2019 when the currency rose sharply within a few moments and also caused the rest of the other currencies to fall.
The difference between stock market and forex market collapses
Stock market collapses are different from the ones we see in the currency market in terms of the fact that stock market falls usually affect most stocks since they are all trading in the same currency. For example, the collapse of the S&P 500 will often lead to sharp declines for the majority of listed companies, as is the case with all other stock markets and indices.
On the contrary, the worn out currency markets usually affect one currency, like the British pound or the US dollar, which usually appear due to the occurrence of unexpected events create shock investors and cause them to sell the work on as rapidly as possible. However, forex trades usually involve two currencies, such as the GBP/USD pair, i.e. the British pound against the US dollar, which means that the dollar will rise as the pound falls.
Based on this scenario, while GBP buyers will experience sharp falls in the value of their trades during this crash period, those sitting on the other side of the trade will make huge gains after taking advantage of the USD / GBP rise.
The same scenario applies to any other currency that may collapse, as the currencies corresponding to it will make strong gains at the same time as the value of that currency is eaten up in the forex market.
The fact that the forex market has a huge number of currencies, each representing a different country and region, means that it is impossible for the entire market to collapse because each currency trades in a pair against another currency, and therefore the corresponding currency will benefit from the collapse of the other currency.
What causes the collapse of currencies?
Now that we have proved that the forex market in its entirety can not collapse overnight, even though some work may be individual declines sharply from time to time, let's take a look at the most prominent cases of collapse the currency markets in the past years. We would like to recall first that there are two main types of price collapses, the first being long-term declines, and the other being instantaneous declines. Long-term declines usually last for months, possibly years, while momentary collapses occur in seconds and usually last no more than an hour.
Regardless of the nature of the price crash, investors of the currency in question incur heavy losses that can sometimes lead to their entire accounts being wiped out.
Long-term currency collapse
The long-term collapse of the currency is often associated with the prevailing social and economic conditions in the country concerned, and therefore usually lasts for long periods. These cases of currency collapse often occur when the country is facing a major crisis, such as a military coup, spiralling inflation or other major economic challenges.
For example, Venezuela's currency is facing a severe crisis as the value of the bolivar has plummeted in the wake of U.S. sanctions that mainly targeted 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 and isolated from the international community, which has severely damaged its economy. This is one of the most striking examples of a long-term currency crisis, the solution of which takes many years.
However, this type of long-term currency crisis often appears in developing countries that lack strong institutions and are mostly managed by authoritarian rulers who implement populist policies that do not satisfy investors, which ultimately adversely affect the country's economy and may lead to its collapse.
Beware of momentary collapses
Forex traders were hit hard by the Japanese yen's momentary and sudden collapse on January 2, 2019, with the Japanese currency jumping 3-5% against other currencies, such as the US dollar, in just eight minutes.
This sudden jump caused traders with open positions on JPY to suffer significant losses/gains. This price jump lasted only a short time but caused great damage to most traders by triggering stop-loss orders in their sell positions, which in some cases led to some accounts being whistled within a few minutes.
Most currency analysts attributed the sudden jump to automated trading systems, especially given that there were no exceptional economic or political events that could explain the resounding collapse, which occurred during a week-long bank holiday.
Some experts pointed out that the price crash occurred between 5pm and 6pm New York time, commonly called the magic hour, due to the lack of liquidity during that period due to the closing of the New York markets while the Japanese markets have not yet opened.
Some experts also pointed to Apple's announcement this week of a weak revenue forecast due to slowing sales in China after the close of the New York session, this announcement may have raised investor concerns and consequently stimulated this momentary collapse.
The collapse of the Swiss franc
A month after the Japanese yen fell, on February 10, 2019, the Swiss franc also suffered an instant, but less severe, collapse during the Asian trading session where it fell strongly against most major currencies, including the US dollar. Most analysts attributed this momentary collapse to low liquidity levels as Japanese markets were closed for the National Foundation Day holiday.
The Swiss franc was exposed to a similar scenario years ago, but this time it was not just an instantaneous climb, jumping to unprecedented levels in January 2015 after the Swiss National Bank announced the disengagement of the franc and the euro and abandoned the 1.20 price stabilization. This surprise announcement caused the franc to jump in moments by 20% against the euro and other major currencies.
It is important to note that momentary collapses are nothing new to the currency markets because they have often been repeated in the past, even though, as we have said, the forex market is not completely collapsing at once. Though, the thing interesting is that the recurrence of landslides longer justified which does not lack for obvious reasons, has become a more common phenomenon in the financial period. That is why we always recommend that you follow the proper rules of risk management when trading in the forex market so as to avoid exposure to heavy losses when instant collapses occur.