The forex and cryptocurrency markets have been in the spotlight in recent years, capturing the attention of investors and traders alike. While these two markets have many obvious differences, they also share some similarities. In fact, there are many cases where they could affect each other as well. Investors and traders who have a clear understanding of the correlation between the two, both in the favorable and less favorable aspects, would have an advantage in terms of analytical capabilities.
The main differences between forex and cryptocurrency
Forex is the world's largest and most liquid financial market, with daily trading volume exceeding $6 trillion, according to Bloomberg. In the case of forex, currencies are sold in pairs, such as EUR/USD or GBP/JPY. This is done with the aim of profiting from changes in exchange rates. According to Yahoo, "Some traders prefer to work with exotic currency pairs, which include a major currency and a currency from a developing economy like South Africa or Mexico."
Cryptocurrencies, by contrast, are digital currencies that use cryptography and function independently of central banks. To back down, central banks play a critical role in the forex market. It is also worth noting that cryptocurrencies carry more risk than forex and other CFDs due to the historically high volatility of the crypto markets. This is why all major FCA regulated UK forex brokers were banned from trading cryptocurrencies for retail investors starting in 2020.
The correlation between the two markets.
Market sentiment is one of the main drivers influencing the correlation between the forex and cryptocurrency markets. When sentiment is good, both the forex and cryptocurrency markets tend to see rallies in the form of increased buying activity, which typically leads to upward price movements. And of course, conversely, when market sentiment is negative, there are downward price movements.
Risk appetite serves as another correlation between the two markets. This refers to the willingness of traders and investors to risk a lot, hoping to win a lot. Thanks to the backing of central banks and governments, Forex is not risky by nature. But it should be noted that certain currency pairs can be more volatile and carry higher risk, especially where emerging markets are involved. When it comes to cryptocurrencies, volatility is simply part of the game and significant price fluctuations can be seen in short periods of time. According to Cointelegraph, โcryptocurrency investors tend to be more risk averse and prefer to let their investments run on autopilot; They don't care as much about daily price changes. On the other hand, traders thrive on taking risks and must have an excellent understanding of volatility and market conditions.โ By extension, traders and investors with a higher appetite for risk are more inclined to invest in both currencies and cryptocurrencies. This leads to a positive consensus and correlation between the two markets. Conversely, negative correlations come into play when traders and investors end up reducing their exposure to both markets. It is also worth noting that cryptocurrencies carries more risk than forex and other CFDs due to the historically high volatility of the crypto markets.
In recent years, there have been cases of traders and investors incorporating cryptocurrencies into their forex trading strategies. In these cases, they would view crypto as an alternative investment and use it as a potential safe haven asset in times of geopolitical uncertainty. This is comparable to traditional safe haven assets like gold. These are the cases where changes in the value of cryptocurrencies could have a potential impact on the currency markets, due to the perceived risks and opportunities in the broader market. Cryptocurrency-related financial products such as cryptocurrency futures, options, and exchange-traded funds created further overlaps between cryptocurrency and the forex market.
Correlations are not always consistent or predictable.
While there are some correlations between the forex and cryptocurrency markets, it is worth noting that they are not always consistent or predictable, and the reasoning obviously boils down to market performance. The hours of operation, as noted by Kiplinger, are very different between the two, as โForex markets see daily trades 24/5. Crypto markets not only see the same type of non-stop activity on weekdays, that action extends to weekends as well.โ Both markets are influenced by factors including economic indicators, geopolitical events, central bank policies, market sentiment, technological development, regulatory changes, and investor sentiment. Collectively, these factors can lead to opposite movements in their respective markets, resulting in a more negative correlation.
For example, in certain situations, the foreign exchange and cryptocurrency markets may show divergent movements that can be traced back to differences in market structure and liquidity. Furthermore, any regulatory changes or announcements related to cryptocurrencies would naturally affect the correlation between the forex markets and cryptocurrencies. For example, if a major economy announces a cryptocurrency ban, it would likely affect cryptocurrency sentiment and prices. By contrast, currency markets would be largely unaffected amid the chaos. This would also apply if there was institutional adoption of cryptocurrencies, as it would affect cryptocurrency sentiment and prices, and again, forex markets would likely remain flat.
At the end of the day, while there are some correlations between the forex and cryptocurrency markets, the relationship between the two is complex and participation in both is not for the faint of heart. That being said, experienced traders and investors are in the best position to analyze and understand the dynamics between the two, while newbies to these realms are better off seeking expert advice to make the most informed trading decisions.
