As deflation hit the economy and prices started to fall, many people believed they would be better off by reducing the spending even further in anticipation of even lower prices. As a result, the extreme drop in demand has catastrophic consequences on the US economy, which later spread to other countries globally. Another popular theory is the monetarist explanation, which believes that the shrinking in money supply was the main cause of why an ordinary recession turned into one of the greatest economic downturns.
Finally, some economists blame the gold standard to be the primary transmission mechanism of the Great Depression. However, it was the suspension of gold convertibility that made economic recovery possible. Almost every major currency left the gold standard during the Great Depression. In , the United Kingdom ceased exchanging pounds for gold after a series of speculative attacks on the currency, which made the country one of the first to recover from the economic downturn.
Japan and the Scandinavian countries followed the UK and left the gold standard in , followed by Italy and the US. Some countries, like France, Belgium, and Switzerland, stayed on the standard until , which caused a slower economic recovery than countries that had freely floating currencies. Although the Great Depression is reaching its th anniversary, it still provides valuable lessons to traders and investors about how severe an economic downturn can be, and how pegged currencies can prove to be a major hurdle for recovery.
One of the more recent black swan event examples in the financial markets was the Asian financial crisis. Singapore, Taiwan, and Japan also felt the consequences of the crisis, although to a lesser extent. However, higher interest rates and economic growth in the region also attracted speculative money that searched for a quick profit. Asset prices kept rising, forming a bubble that required even more capital to be maintained.
The crisis started with the collapse of the Thai baht on July 2, , after the government lifted the currency peg to the US dollar due to lack of foreign reserves. As a result, capital outflows started almost immediately, leading to a sharp sell-off in the Thai baht, and later in other Asian currencies as well. The fact that south-east Asia accumulated a huge pile of foreign debt made the devaluation of their currencies even worse.
Figure 1Source: www. Currency markets were the most hit during the crisis. The Thai baht fell from The Indonesian rupiah was hit the most. The dot-com bubble, also known as the Internet bubble, was a bubble in the stock market in the late s, mostly fueled by excessive speculation in internet-related companies.
The advance of the internet and massive adoption of computer technologies nursed many new companies that were focused on the internet, including names such as Pets. Speculative capital began to flow to newly-founded companies that were mainly focused on delivering their services over the internet. Investment banks were also profiting from a surge in IPOs and encouraged investment in the new internet companies. At the peak of the dot-com bubble, internet companies were able to become public companies and organize an IPO without a penny of profits.
People started quitting their jobs to trade the financial markets, and many employees who received stock options became instant millionaires. Some popular companies, like Amazon and Cisco, were also hit hard but managed to survive the drop in their market capitalization. The bursting of the bubble was initiated by several smaller events.
First, former Fed governor Alan Greenspan announced that the central bank is planning to hike interest rates in , which led to increased market volatility and concerns of higher borrowing costs for internet companies. Then, Japan entered into a recession in March , triggering a worldwide sell-off in internet companies and technology stocks.
In November , Pets. And finally, the September 11 attacks in accelerated the sell-off in dot-com companies even further. One of the more recent black swan events was the Great Recession, also known as the global financial crisis. This was a severe financial crisis that started with the housing market bubble in the United States and quickly spread to the rest of the world. Commercial banks took excessive risks with mortgage-backed securities which fell in value dramatically after the bursting of the United States housing bubble.
A Black Swan event describes an unexpected event that shocks the world by its impact and the magnitude. SNB released currency peg — click to enlarge. Traders who were positioned on the wrong side of the markets under such conditions could easily lose their whole trading account and even end up owing their broker money because, getting an order fill and exiting positions under such circumstances is almost impossible due to the unilateral liquidity.
You might say that such Black Swan events are very rare and you are right. But it is enough to be on the wrong side of such an event only once. In the course of a trading carreer, such events are likely to happen multiple times and being exposed to such a market shock can lead to losses that exceed all previously made profits over years and decades.
It is therefore important to take precautions to protect your trading capital and your savings. It usually says something like this:. A regular stop loss does not protect you and does not eliminate trading risk. When price reaches your stop loss, your order is closed.
In case of slippage and price gaps, the price your stop loss is executed at can be substantially worse than the actual stop loss order. But when an unexpected piece of news hits the market and price gaps, your broker cannot guarantee that your stop loss is actually being executed at the price level where you set it.
During Black Swan events, it is likely, and almost guaranteed, that your stop loss order will be executed hundreds or even thousands of points later, after the trade has wiped out your whole account. As we have mentioned, losses can even exceed the initial capital and you can end up owing your broker money another reason why reading the fine print of the terms is important. Some brokers offer guaranteed stop loss orders where they will always execute your order at the price you set it to.
Segregation of funds means that brokers offer a protection of your trading capital and that customer funds are kept separated from the assets and the capital of the broker itself. In case of insolvency, or bankruptcy, the segregated accounts and customer funds have a preference.
Therefore, before choosing a broker you should first check whether the broker offers segregated accounts at all and to which extent you can get your money back in case of financial turmoil. Black Swan events in particular can be the cause for solvency problems when suddenly the majority of clients loses a big stake of their capital or even loses more than their initial deposit. There is no one size fits all. However, often traders don't really know what their indicators Comments 2 Suresh 18 Oct Hi Rolf, What are the measures we traders can take to avoid the negative balance — unlimited liability — other than the below.
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After a black swan event occurs, analysts often sift through the data to come up with a plausible explanation. However, it is impossible to predict a black swan event ahead of time. The black swan event often has extreme implications. The impact could be either positive or negative. A black swan event which has a positive impact. Examples for this include the evolution of the internet or the mobile phone industry. The common factor is that these events seemed unthinkable a decade before.
Similar to a positive black swan event, negative black swans also have an extreme impact. Lastly, one quality that qualifies a black swan event is the improbability for it to occur. This comes largely due to the perception of humans. Another distinct character of a Black swan event is that the same event does not repeat again. History has offered numerous examples of black swan events that makes for a good study. The past black swan events can help the reader to understand the black swan theory.
It also offers insights on how investors and speculators in the financial markets can use the past experiences to better protect themselves. The dot com crash spanned two years. The dot com era emerged after the emergence of the Internet. Boasting of nearly 18 million users at the time, the Internet caught on commercially. This led to an influx of capital which turned many small companies into overnight publicly listed stocks. Interestingly, some of the companies that emerged during the dot com boom were the likes of Amazon Inc.
EBAY to name a few which survived the crash. The most famous example of the dot com bubble was pet. An online store that allowed customers to purchase pet supplies. The company debuted in February of and went bust in under a year. During the height of the dot com boom, anyone with an idea to build something online quickly became an overnight sensation.
The optimism was fueled by banks also actively participating as underwriters. For the banks, profits came mostly from underwriting and investment fees rather than investing in the stocks. Before the bubble burst, a market crash was unthinkable. Cracks started to emerge by early The Nasdaq which surged strongly lost over a trillion in market valuation within a month. This came as companies began to report losses.
The losses came as basic logic was shown the door as investors grew exuberant. While in hindsight it would have been easy to see the crash, the optimism in the build up to the crash certainly blinded many. The mortgage crisis started in and was the aftermath of the housing market boom. The U. The mortgage crisis emerged after the U. Federal Reserve cut interest rates to historically low levels.
Fueled by cheap credit, lenders began to extend mortgages even to those with weak credit histories. Sentiment in the economy was high, rather clouded and at one point a mass default was deemed improbable. The black swan event of wiped out billions in valuation, left many people without a job and caused some leading financial institutions to bankruptcy.
Within no time, as the mortgage rates started to rise, the number of defaults started to grow. The default on mortgages hit a peak in As job losses started to grow it was difficult for the average home owner to refinance their mortgages. This led to a meltdown in the financial markets. Financial institutions on their part also played a major role. The development of mortgage related securities became famous and every other bank started to trade with them.
The central bank of Switzerland announced that it was going to terminate the cap on the Swiss franc. The SNB had a program in place to keep the euro from falling below 1. This event had far reaching implications in the spot forex markets as some online retail forex brokerages went bankrupt. Even day traders were not spared. Even the large and well established forex brokerages were not spared.
FXCM Inc. Prior to the SNB giving up the floor, market participants considered it to be unthinkable. The central bank announced its currency peg in Despite retail and institutional trades repeatedly testing the floor of 1. Over a period of time, the retail investing community took it for granted.
It quickly became the norm that no matter what, the Swiss national bank would continue defending the floor. It was due to this complacency that traders started to feel at ease. Every time the Swiss franc increased in value, the central bank would purchase foreign exchange to weaken the franc.
As with a black swan event, the rationalization that came after the event tried to explain the central bank actions. Reasons given included the Swiss citizens ire against the central bank amassing huge forex reserves to defend the currency peg. As always, be safe and trade responsibly. Join our community today on Discord and chat with our traders and other Members! Forex Lens provides Forex trading solutions for beginners and expert trader alike. Feel free to email or call us with any questions, comments or concerns.
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A special treat for Forex traders is this black swan risk event that happened in the currency markets. It's a textbook example of how sudden and. A “Black Swan” is -by its definition of an event- inherently possible in our lives. The FX market is a complex system which is created by human beings. A Black Swan event describes an unexpected event that shocks the world by its impact and the magnitude. For example, the 9/11 attacks or the Tsunami in Japan.