29 August 2023
Emerging Markets in 2023: A Forex Trader's Ultimate Guide
Forex markets are shifting, with traders finding opportunities in emerging markets. These are countries whose economies are transitioning from low-income to more developed. They usually feature a high economic growth rate, improving living standards, a rising GDP (Gross Domestic Product), low per capita income, and improved investment flows.
The more emerging markets develop, the more they are integrated into the international economy, making them more accessible to foreign investors. Their growth also translates to increased liquidity in the local debt and equity market and trade volume.
The significance of emerging markets in the global economy cannot be underestimated. To begin with, they allow multinational organizations to access new markets and expand their operations, presenting more investment opportunities for traders.
The economies also benefit the international supply chains by contributing natural resources like oil, gold, energy, gas, and metals. Moreover, emerging economies continue to play a vital role in helping create new trade patterns between countries.
So, what are the top emerging markets in 2023? What investment strategies are available? And what are the potential rewards and risks of these markets? This forex trader's guide seeks to answer all these questions for you comprehensively.
Top Emerging Markets in 2023
Emerging markets have the potential to become important players in the forex market. They also present an excellent opportunity for traders to diversify their portfolios. Here are the emerging markets to look out for in the 2023 economy:
India's economy has been growing fast for the last three decades. Despite experiencing an economic crisis in 1991 that almost brought it to its knees, India’s success resulted from the reforms introduced to create a favourable economic environment. Consequently, the country has attracted considerable foreign investment and massive technological innovation.
The primary growth factors in India are an increasing working-age population, political stability, infrastructural development, and rising education levels. The most essential and fastest-growing industry of the Indian economy is services. For instance, insurance, financing, trade, hotels, real estate, transport and communication, and business services contribute over 60% to India's GDP. However, more than half of the working population is employed in the forestry, agriculture, and fishing sectors, where the GDP is about 12% of the output. The manufacturing and construction sectors account for 15% and 8% of the country's GDP, respectively.
Until some decades ago, India's foreign policies were basically defensive. Fortunately, the government has relaxed the policies to expand the economy. For instance, companies in the foreign exchange market are now permitted to accept foreign direct investments (FDIs).
This means they can buy (at least 10%) ownership in a firm in a foreign country. Previously termed as a regulator, the Reserve Bank of India currently plays the role of a facilitator. As such, it allows foreign institutional investors to put their money in Indian financial markets like pensions and mutual funds.
Given the booming economy, it goes without saying that India is a good candidate for the global forex market. As investors flood the country, interest in forex trading is bound to increase. India's entry into the global financial system could make it a critical forex market player. Furthermore, the nation's influence on currency markets could become more pronounced as the Rupee's popularity in the international market grows.
China has a $17.7 trillion GDP, making it the world's second-largest economy. The country, categorized as low-income just a few decades ago, has experienced remarkable economic growth. How? China's success is accredited to opening up to global trade and economic liberalization by establishing business and diplomatic relations with the US in 1979. This fueled its export growth, leading to a rapid expansion in manufacturing and urbanization.
Currently, China is the leading manufacturer in the world and generates nearly half of the globe's steel. The economy also provides transportation devices, machinery, cement, food processing, and consumer goods. The services industry, which absorbs the largest portion of China's population, has also driven its GDP growth rate. The agricultural sector accounts for about 10% of the nation's GDP, as most agricultural output focuses on filling domestic demand. Nonetheless, China still exports soft goods like wheat, rice, soybeans, and corn.
An open-door policy allows China to trade freely with different countries, driving economic growth. The special economic zones (SEZ) policy further works to China's advantage. By dividing its regions into various localities that operate without the central government's oversight, the nation can draw domestic and foreign investors through different incentives. These include tax reliefs, lower tariffs, low-cost labour, etc.
China's financial markets are now more accessible, thanks to market liberalization and financial reforms. This is a good environment that can foster forex trading. China's Belt and Road Initiative, which promotes trade connectivity in different regions, can trigger forex activity. Furthermore, the People's Bank of China's move to interfere less with the Chinese Yuan's (CNY) exchange rate is a step in the right direction. Trading with this currency could become more favourable now that market forces can influence its value.
Mexico is ranked the 15th largest economy worldwide and Latin's second-largest after Brazil, owing to its $1414 billion GDP. For the last ten years, Mexico's economy has been growing at an estimated rate of 2.1% amidst a complex international environment. Some sectors that drive economic growth are agriculture, oil and gas, exports, mining, tourism, and manufacturing.
The aerospace and automotive industries have recently gained importance in the country. In fact, the latter has boomed in recent years, making Mexico the 4th biggest auto exporter. This has prompted automotive firms like Toyota, Nissan, General Motors, and BMW to increase production in the country or plan to do so.
Mexico is also becoming a primarily middle-class nation, with half its population falling into this class category. This means that the consumption rate is rising, vital in propelling the economy forward.
Mexico's economic strength is based on accountable financial, economic, and commercial policies focusing on building the domestic market. For instance, its economic development strategy includes reinforcing consumption through social programs and promoting financial inclusion. This enhances private investment in different sectors, augmenting public investment and trading relations with foreign countries.
One of the characteristics of Mexico that can make it a promising player in the forex market is its export-oriented economy. By trading with other countries and supporting foreign direct investment, Mexico's currency (Pesos) and other major currencies can generate forex activity.
Another factor that makes this Latin country a significant participant in forex is its economic significance on the global level. The growing economy continuously influences traders to work with MXN-related pairs to leverage economic developments.
Whereas many forex strategies are available in order to make informed trades, some are specifically tailored for emerging markets. Here are the options that you may find useful:
Currency carry trade approach
A currency carry trade strategy entails utilizing a low-yielding currency to purchase high-yielding units. The approach resembles the trading principle of "buy low, sell high." Let's say the USD provides a higher yield than a currency like the Indian Rupee (INR). You may profit by taking long positions on the USD and going short on INR. This is where you borrow INR at a reduced interest rate to purchase USD at a higher interest rate, earning profit from the gap. A good example is when you discover that rates in India are 0.5% and 4% in the US. This implies that you anticipate earning a 3.5% profit– the difference between the two rates.
The ideal period to implement the carry trade strategy is when central banks raise or contemplate raising the interest rates. This is when many traders will use the approach, pushing up the value of trading assets. As long as the currencies' values don't fall, your chances of being successful are increased. Unfortunately, periods of interest rate decrease don't provide substantial gains. When rates are downward, a currency's demand also tends to decrease, making it difficult to sell the currency.
This is a trading approach where the trader holds positions for a long time, anywhere from several weeks to months or years. The goal is to take advantage of long-term price movements and trends in the forex market.
Analyzing several major indicators in emerging markets is vital to identify cyclical trends to be more successful as a position trader. These can include things like GDP growth, political developments, monetary policies, and inflation rates, among others. For example, increases in GDP often strengthen currencies, while reduced growth does the opposite.
Monitoring an economy's GDP status over time thus gives you a chance to gauge which period is ideal to invest in a currency. Although position trading doesn't let you open many trades, it may generate more income in the long run.
Trend-following based on sentiment changes
Working with a strategy that relies on market sentiment can give you a valuable advantage in the forex market, enabling you to comprehend and react to price behaviour. Market sentiment analysis in this context focuses on determining how investors feel about the financial markets or an asset in emerging economies.
A trend-following strategy seeks to align with the existing market sentiment and enter trades in the direction of the established trend. For instance, if the mood in the market is favourable, investor sentiment often turns bullish on currencies from emerging economies. This can be an opportunity to instigate long positions as you expect the uptrend to persist.
This approach monitors the correlations between the prices of commodities (e.g., gold, oil, metals) and currencies. Many emerging economies rely on commodities, so changes in commodity prices can affect their currency values.
A positive correlation means that the two assets move in tandem, while a negative one indicates a move in opposite directions. For instance, Mexico's currency correlates positively with its natural resources, so it often fluctuates with commodity price shifts. You can use this to open an MXN position when it moves alongside a commodity like oil which may increase your prospect of been successful.
Emerging market currencies usually exhibit varying characteristics different from their developed counterparts. They can be more volatile and experience sharp devaluations. Using hedging strategies helps you manage the risk of these currencies more effectively. This is where you take an offsetting position in a related currency to decrease or eradicate the exposure to undesirable price movement.
Assume that you have taken a long trading position on USD/INR at 80.95 but are concerned that the price could decrease in light of an upcoming news release. You can mitigate this risk by buying a hedging contract known as a put option. This gives you the right to sell a currency at a certain price within a specified period. In this regard, you can purchase slightly below the current exchange rate, like 80.75. This significantly decreases your risk of losses.
Risks and Rewards
Trading in emerging markets has its fair share of ups and downs. Here is a breakdown of the rewards you can expect to get and the risks you may be exposed to:
Emerging markets will likely earn good returns due to their high growth potential. When their economies develop, many industries perform well, and the demand for goods and services rises. All these propel local currencies' value upwards, increasing profits for traders in the forex market.
Another benefit you stand to enjoy by investing in emerging markets is diversification. When you invest in companies based in these economies, you will likely decrease your overall investment risks. How?
Generally, emerging markets are less correlated with developed markets like Europe and the United States. If one market faces a depression, your investments in other markets will not be significantly affected. In a way, trading currencies from emerging economies help you spread risk, possibly counteracting losses in one asset with profits in another.
Opportunities for globalization
As seen earlier, emerging markets, such as India, Mexico, and China, have increasingly opened up their economies, allowing cross-border interactions. This is advantageous in that it fosters economic growth and promotes investment activities.
As more traders worldwide join these markets, the value of the currencies increases, creating more avenues for profit. And by accepting to work with more foreign countries, emerging economies offer traders access to a broader range of assets, allowing them to expand their portfolios.
Leveraging geopolitical events
These events may include global political developments, diplomatic changes, treaties, and conflicts affecting how countries relate. Overall, these occurrences are quite common in emerging markets and tend to affect currency movements significantly. As a trader, you can take advantage of sudden positive price swings to maximize your profits in the forex market.
Currencies in emerging markets are highly susceptible to fluctuations. This can be attributed to political instability, economic uncertainties, abrupt changes in global market sentiment, etc. These can cause sudden changes in currency value and impact your investments negatively. Therefore, it's advisable to have a robust risk management strategy to help you navigate this risk.
Currencies in emerging markets have restricted trading volumes over major currencies, creating liquidity issues. The liquidity levels of these currencies can even reduce significantly when the forex market is in turmoil. This can make it harder to implement trades without substantially impacting prices.
There is the risk of having wider slippage and bid-ask spreads which can increase your trading costs. In light of this, exercise caution as you navigate different market conditions.
Unlike developed economies, emerging markets don't have accurate and comprehensive economic data. This may be attributed to inadequate resources, transparency issues, and not being updated on new data collection methods.
The information gap can make it hard for you and other traders to assess indicators that help you make informed decisions. So, there's a high chance of misjudging currency valuations and potentially making losses.
Some emerging markets have less stable governments, while others experience rampant corruption. Therefore, they can abruptly establish new restrictions, controls, or foreign exchange policies. This can significantly disrupt or limit your forex operations, leading to unnecessary financial losses.
You can mitigate this challenge by staying updated on regulations in these countries and adjusting your trading strategies accordingly.
Emerging markets present lucrative trading opportunities for the currencies market, but significant risks are involved. The good news is that you can adopt various strategies to help you efficiently manoeuvre the challenges and make more informed trading decisions. Ensure you research the market you trade in to comprehend the economic indicators, policies, etc.
Also, track geopolitical events to discover how they impact currencies to help you make wise trading moves. Don't forget to develop risk management strategies that will help safeguard your investments from unexpected happenings. Lastly, work with varied strategies that can easily adjust to changing market conditions and currency fluctuations.
Disclaimer: Any information presented is for general education and informational purposes hence, not intended to be and does not constitute investment or trading advice or recommendation. No opinion given in the material constitutes a recommendation by M4Markets that any particular investment, security, transaction or investment strategy is suitable for any specific person.
It does not take into account your personal circumstances or objectives. Any information relating to past performance of an investment does not necessarily guarantee future performance.
Trinota Markets (Global) Limited does not give warranty as to the accuracy and completeness of this information.
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