AI, Digital Currencies, and ESG are shaping currency trading strategies

Advancements in technology, including artificial intelligence (AI) and algorithmic trading, are set to have a huge impact on forex trading, according to Bianca Botes, foreign exchange expert and director at Citadel Global.

“AI is likely to lead to increased market automation and the use of high-frequency trading strategies. This could result in faster and more efficient price discovery in currency markets, as well as changes in the dynamics of how economic indicators impact currency prices,” Botes says.

Other important trends are central banks’ monetary policy strategies, including shifts towards unconventional tools such as yield curve control, and the growing popularity of digital currencies, including central bank digital currencies (CBDCs) and cryptocurrencies.

Botes says this introduces new dynamics into currency markets. While digital currencies may initially co-exist with traditional fiat currencies, they could eventually impact trading strategies as they become more integrated into the global financial system.

Furthermore, the increasing focus on environmental, social, and governance (ESG) factors is having a growing impact on currency markets and trading strategies. Botes points out that investors will prioritise currencies of countries with strong ESG credentials, leading to shifts in capital flows and currency valuations.

Impact of geopolitical events and global economic trends

The volatility of the rand against the US dollar and other major currencies is a trend that is keeping many South Africans up at night. Botes says geopolitical events and global economic trends also have a direct influence currency performance and risk management.

“How well the dollar performs and how it impacts the value of the rand is greatly impacted by factors such as the US employment figures, inflation rates and gross domestic product data, pronouncements by the US Federal Reserve, and locally, South Africa’s trade balance, GDP, inflation levels, unemployment figures, and guidance from the South African Reserve Bank about monetary policy.

“We are also closely watching the impact of the continuous tight monetary policy over the past two years around the world, and the anticipation of central banks moving to a looser stance,” says Botes.

According to Botes, geopolitical events and global economic trends interact with economic indicators to shape currency market dynamics in several ways. Global events seriously impact the risk appetite of investors, the movement of commodity prices, the stability of traditional trade relationships, the existing exchange rate differentials between countries, and which asset classes investors turn to as safe havens.

“Economic indicators related to economic stability, fiscal health, and monetary policy credibility become particularly important during volatile periods such as the one we are experiencing now, and these factors all influence currency market dynamic,” she explains.

One crucial economic indicator that is easily overlooked is trade balance data. The trade balance reflects the difference between a country’s exports and imports of goods and services. A positive trade balance (surplus) occurs when exports exceed imports, indicating that the country is selling more goods and services abroad than it is buying.

Botes explains this can lead to increased demand for the country’s currency as foreign buyers need to exchange their currency to purchase goods and services, thus strengthening the currency.

“Conversely, a negative trade balance (deficit) occurs when imports exceed exports, indicating that the country is buying more goods and services from abroad than it is selling. This can put downward pressure on the country’s currency as more of it is sold to purchase foreign goods and services, leading to currency depreciation,” she adds.

How to adapt currency trading strategies based on new economic data

“Currency trading requires preparation, analysis, and swift decision-making. A key part of the process is interpreting and reacting to economic data releases in real-time,” says Botes.

She shares a concise overview of the process:

  • Preparation: Currency traders maintain a calendar of economic events and data releases, including indicators like GDP, inflation, employment, and trade balance. They anticipate the potential impact of each release on the currency markets based on consensus forecasts and historical trends.
  • Analysis: When economic data is released, traders quickly assess whether the actual figures meet, exceed, or fall short of expectations. They compare the newly released data to previous readings to gauge the direction and magnitude of any changes.
  • Market reaction: Traders closely monitor the initial market reaction to data released. If the data significantly deviates from expectations, it can cause sudden volatility in currency prices. Traders assess the strength and direction of the market movement to determine potential trading opportunities.
  • Decision-making: Based on their analysis and market conditions, traders decide whether to enter, exit, or adjust their positions. They consider factors such as the significance of the data release, the duration of the market reaction, and their risk tolerance.
  • Risk management: Traders implement risk management techniques to protect their capital and minimise losses. This may include setting stop-loss orders, adjusting position sizes, or hedging against adverse market movements.
  • Adaptation: Economic data releases can sometimes be unpredictable, leading to unexpected market movements. Traders must remain flexible and adapt their strategies as needed to respond to changing market conditions.

Botes believes the current heightened levels of geopolitical uncertainty are likely to be sustained in the coming months, not just from a military conflict perspective but also from a trade relations perspective therefore, traders must navigate geopolitical risks and developments, and this is best done with real-time data.

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