Traders Ditch Dollar as CFDs Gain Ground

This time last year, many retail traders were wondering whether the volatility caused by central bank monetary strategies to combat inflation by raising interest rates would persist. They received their answer within weeks as Russian tanks rumbled into Ukraine and the world suddenly felt like a more dangerous place.

At such times, the traditional approach is to pile into the US dollar. But, dollar weakness has been the key market trend in recent months with an uber-hawkish Fed and rising inflation now in the rearview mirror. As the rest of the central banking world play catch-up with the US, rate differentials have narrowed and, thus, added to the downside pressure on the greenback.

“China’s reopening has prompted a surge in China-sensitive currencies such as the Australian dollar,” explained Justin McQueen, a Market Specialist at Capital.com. “Combined with natural gas prices falling off a cliff, this bodes well for the euro with the economic outlook looking comparatively more optimistic than just a few months ago.”

According to McQueen, these big macro events have contributed to increased interest in FX trading with traders taking a view on USD's potential recovery and where the yen will gravitate next. “Interest in USD/JPY picked up in the early weeks of this year,” he continued. “It is still too early to identify specific levels of increase from last year, but FX markets have so far been one of the top three most traded markets on our platform in 2023 with EUR/USD and GBP/USD also among the most popular pairs traded.”

In 2022, Capital.com traders chased momentum by nearly tripling the number of trades made compared to 2021, gradually diminishing their net long holdings in favour of net short positions and becoming more cautious by increasing the number of trades with stop-loss orders. This indicates that retail traders were engaging with the major macroeconomic events that impact a currency and were ready to modify their positioning during moments of elevated volatility.

In terms of specific products, CME Group reported a decline of just over 7% in rolling three month average daily volumes for FX futures and options in January compared to the previous month.

FX traders are seeing larger profit/loss swings than they might have known for the last decade or more. Such volatility is cyclical and likely to come down at some point, but the question of ‘when’ makes greater education around risk management essential for retail traders. That is the view of Pete Mulmat, the CEO of IG US, who refers to trading growth being driven by the same three currency pairs as McQueen.

“The action has been in those majors,” he says. “That said, a resurgence in the Australian dollar has brought pairs including that currency back onto many traders’ boards.”

In 2023, fears of a global slowdown look set to dominate as the impact of interest rate hikes begins to take hold. While many central banks will be looking to end their hiking cycles this year, the pace at which they do so is likely to differ, and this will be a key element of trading.

“If some of the smaller central banks are forced to turn dovish on economic weakness ahead of the bigger banks, it is likely that there will be more divergence to trade for both FX day traders and skilled investors alike,” observes Stavros Lambouris, the CEO at HYCM International.

A good example of this is the Reserve Bank of Australia (RBA). Recent inflation data came in above the market’s maximum expectations, which has made the case for a more aggressive RBA and a terminal rate that could rise higher than 3.5%. On balance, this should keep the AUD supported against the NZD and traders should watch for divergence between the RBA and the Reserve Bank of New Zealand for trading opportunities.

“Central bank intervention will continue to play a key role in FX trading,” adds Lambouris. “Traders are accustomed to keeping up with the latest moves, and we often see the markets anticipating policymakers’ reaction to economic data – whether it is new inflation print or employment figures – to establish the state of the economy.”

With US inflation expected to fall around 3% by the end of the year, concerns are likely to transform into wider fears about global growth and recession. Previously, many analysts were predicting a bounce in the dollar as fears of a US recession (followed by a global recession) dominated. Now, the increasing likelihood of a soft landing from the Fed is causing analysts to cut their forecasts of the USD’s performance this year, and emerging markets are expected to gain at the expense of the greenback.

“Continuing geopolitical tension around the globe will have a major impact on trading,” says Lambouris. “With the conflict between Russia and Ukraine approaching its one year mark with no end in sight, it may be difficult to price in risk. However, talks of a ceasefire could lift all financial markets around the globe in 2023.”

Muamar Behnam, the Head of Global Retail Sales at Swissquote reckons diversification within traders’ portfolios is the main trend in the retail trading space in the early months of 2023.

“We see fewer traders trading only currency and a move towards diversification just like in the more traditional non-leveraged side of the business,” he says. “The trend is clearly towards portfolios with a combination of currencies, bullion (gold and silver), energy and agricultural commodities.”

Furthermore, Behnam refers to increased interest in single-stock CFDs. He agrees that retail traders are more aware of what is going on in the world and that the conflict in Ukraine, rising interest rates, and inflation numbers have all had an impact on trading behaviour which is not going to stop any time soon.