When you hear about forex trading, you think about currencies from leading industrial economies. But over the past few years, the currencies of developing countries have started to play a significantly important role in international financial markets.
As a result, if you’re interested in forex trading, you will need to understand the unique challenges and opportunities faced by emerging markets.
Emerging markets can be defined as developing economies that are becoming industrialized and growing rapidly. The securities markets in these countries are heading toward the same standard as developed countries, but they’re not there just yet.
Emerging markets range from countries like Mexico and India. When you compare their banking and financial systems to developed nations, they’re probably still forming. Further, the middle class may be small or nonexistent in these economies.
As a result, these emerging economies can be highly volatile, swinging from extremes of economic decline to prosperity. So you can say that emerging market currencies are those from nations displaying these characteristics.
A characteristic common to these nations is political instability. As a result, you never know what government actions will suddenly move against investors. As a result, investing in the currencies of developing countries comes with significant risk because the political arena is unpredictable.
For example, if there is a sudden government coup, there’s a potential to incur large losses. Further, your investment can even get frozen, negating your ability to withdraw. But these are extreme circumstances that you don’t hear about very often.
These currencies aren’t structured like those of larger economies where the independent currency is allowed to float somewhat freely. Emerging markets are forced to peg their currency against another foreign currency which is usually the U.S. dollar or a “basket” of foreign currencies.
If you’re new to forex trading, the currencies of developing countries may not be a practical option for you. These markets usually suffer from large bid-ask spreads and illiquidity that can have dire consequences during market volatility.
Having said that, higher volatility also provides opportunities to make higher profits, but it comes with the risk of incurring drastic losses.
Investors not trading in emerging market currencies aren’t completely free of exposure to its volatility. When you buy a foreign currency, you’re doing so with your own domestic currency. Further, stock and bond investors routinely place high bets on the movement of these currencies. As a result, the influence of emerging markets can be far reaching.