Part III. Fundamental Analysis / Chapter 4. Currency Interventions

When trading in the Forex market, it is important to understand that it is a well-functioning system, and without understanding it, it is impossible to achieve success. The currency market is closely connected with state institutions such as the Ministry of Finance and the Central Bank. The Ministry of Finance is responsible for the fiscal (budgetary) policy of the state, while the Central Bank implements the monetary (financial) policy. Together, these institutions form the financial system of the country.

The Central Bank plays a crucial role in the credit and monetary system of a country, as discussed in the chapter on bank interest rates. In this chapter, we will focus on the Central Bank and its currency interventions, which are conducted to regulate the exchange rate and, consequently, the economy of the country. We will specifically examine what conclusions a private Forex trader should draw from this information in order to avoid unexpected losses.

You have likely encountered the concepts of supply and demand curves and equilibrium price in the course of studying economic theory at university lectures. To some extent, these concepts directly relate to the Forex market. To simplify understanding, let's imagine a market where everyone is selling apples. You also decide to sell apples and join a hundred other sellers. Since there are many sellers and intense competition, it is unlikely that you will be able to sell your apples profitably. In such market conditions, the price of apples is low. However, let's assume that you have enough money to buy half of all the apples in the market. You hire people who, pretending to be buyers, start buying apples. This commercial move will artificially increase the demand for apples, resulting in a price increase. Riding the wave of excitement, you can sell all your apples and the apples purchased by the people you hired at a favorable price. Of course, the approach described above is risky because there is no guarantee of 100% success. Antitrust authorities may become interested in the sudden increase in apple prices, negative rumors about the use of pesticides in apple cultivation may negatively impact demand, or the apples you purchased may simply rot. As you can see, it is a delicate matter, but its essence is crucial: increasing demand for a product leads to an increase in its price, and vice versa, a decrease in demand leads to a decrease in price. The same principle applies to the Forex market.

Every Central Bank holds reserves, which include foreign currency, foreign securities, gold, and other assets. If a country's economic policy favors a high exchange rate of its national currency or aims to stimulate its appreciation, the Central Bank can conduct currency interventions by selling its foreign assets and buying the national currency. These interventions are typically carried out in large volumes, as the liquidity of the Forex market is significant, allowing individual participants to speculate on currency rates for their own interests. Conversely, if a low exchange rate of the national currency is advantageous or needs to be stimulated, the Central Bank can sell the national currency and acquire foreign currency assets through currency interventions, also in significant amounts.

Market participants in the Forex market generally view currency interventions negatively because even professional traders often incur significant losses as a result. Technical analysis tools are powerless in predicting currency exchange rate behavior in the face of direct interventions by Central Banks. No one provides advance notice of such interventions, and rumors about upcoming currency interventions often remain mere rumors. However, even these rumors alone can temporarily disrupt the sentiment of market participants in the currency market.

Currency interventions can be classified as direct or indirect. In direct interventions, the Central Bank conducts operations in the currency market on its own behalf, and the details of these operations, such as the amount and date, are subsequently communicated by news agencies. In indirect interventions, a series of commercial banks execute operations on behalf of the Central Bank. Indirect interventions are more common in the Forex market and have a greater impact due to their unexpected nature.

Currency interventions can be carried out in the direction of the prevailing trend to strengthen it or against the trend to correct it. Interventions in line with the trend are more likely to achieve the desired result compared to interventions against the trend. Even for a financial institution like the Central Bank, it is not always possible to influence the exchange rate in its favor.

To mitigate the consequences of unforeseen currency interventions, private traders need to stay informed about global economic events, analyze financial announcements, and consider the forecasts of analysts. When placing orders, it is important to always set stop-loss and take-profit levels to limit potential losses in the event of currency interventions.

Being aware of market conditions, having a sound risk management strategy, and staying adaptable are crucial for traders to navigate the potential impact of currency interventions and minimize their potential losses.

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