CENTRAL bank intervention in the forex market is not unusual and presents significant opportunities for profit, but also risk. Interventions are usually in response to long-developing and unwanted misalignments in market valuation. As these misalignments develop, the trader must be alert to the increased risk of intervention and the specific characteristics of interventions that create opportunities for profit.
Intervention is almost always undertaken in the opposite direction of the current market trend. This means that there are opportunities to profit by taking a position ahead of intervention and liquidating the position after intervention occurs. Historically, Central bank interventions have had significant short-term impact on currencies. Following the trend, a trader may also decide it’s prudent to exit the trade and re-enter the market after intervention.
After intervention, price fluctuations can be dramatic depending on the size of intervention and whether the intervention is unilateral or coordinated. Most interventions, however, have only transitory effects on an exchange rate. Unilateral interventions generally have limited lasting impact. Coordinated interventions have been more successful, but are relatively rare. The significant short-term price movements caused by the launch of an intervention present an opportunity to enter a trade at better valuations and the choice to speculate with the central bank or against it.
Another characteristic of interventions is that they are usually preceded by verbal clues from central bank and government officials prior to actual physical intervention. Knowing there is misalignment in the currency valuation, and having the added information that central banks threaten to intervene, presents the opportunity to act ahead of the intervention. Interventions don’t always emerge after verbal threats, but when they do, they tend to be at levels of prior interventions. Knowledge of these levels can be used for the placement of stop loss orders and risk management.
What is important to remember, however, is that the forex market is much bigger than any central bank. Even if a central bank does intervene, the effects are usually short-lived. As such, trading a bank intervention presents very good opportunities, but only in the short term.