As per the butterfly effect, the concept of a small action in one part of the world having a huge effect in another area isn’t a new one, but actually, it works as a great comparison when looking at the impact of small fluctuations in exchange rates.
Like a butterfly’s wings, exchange rates tend to make small movements up and down very quickly. Usually, these movements are minimal and for the general individual or business, one movement isn’t going to spell success or a disaster. It’s only very large hedge funds or corporations that will gain or lose significant funds from small movements such as GBPUSD moving from 1.3730 to 1.3729. However, as with the concept of the butterfly effect, one small movement can trigger further small movements, which gain momentum, shaping the direction of that currency pair, causing the market to move in a certain way.
Blink and you’ll miss it
Due to the fact that the markets are constantly changing it may feel as though you can’t take your eyes off the rates in case they begin to move against you. This is understandable and there are many business owners, buyers, and Finance Directors who will sit crossing their fingers that the rate stays in their favour. There are ways to protect yourself against volatility that we cover later in this article but one thing you can do is utilise tools that will watch the market for you or indeed individuals who stay on top of the rates every day.
With market orders you can pre-determine a rate that is favourable for you to either buy or sell at and when the market hits that rate, the system will trigger and your trades will be made. This is a way of guaranteeing a particular rate (should the market hit it), which is particularly useful if you need a certain rate to ensure profits are not damaged. Of course, there is still some risk involved in whether the markets will hit your desired rate, so you can set a target rate as well as a stop loss to ensure you have a minimum rate locked in. This will enable you to take your eyes of the currency market as you have already set rates that will trigger trades automatically.
Having a foreign exchange expert by your side allows you to be presented with the facts of where your currency exposure lies and the available options should you wish to make a trade. Currency UK’s default view is risk-averse and we can present our clients with products capable of helping them mitigate their FX risk and protect their bottom line where possible. Through the use of rate alerts or currency newsletters, you can be updated on relevant market news and latest rates, giving you peace of mind that an expert is watching the market on your behalf.
Forecasting the storm
The butterfly effect is also known as ‘sensitive dependence on initial conditions’ which backs the idea that forecasting the future can be nearly impossible. This is the same when it comes to exchange rates, despite this apparent impossibility many people try to second guess the FX market often putting profits and savings at risk.
You can’t stop the fact that a butterfly at some point somewhere in the world will flap its wings and whilst of course the likelihood of that being the sole or a significant factor in causing a storm is extremely low we still prepare for the eventuality that a storm can happen. Why is all this butterfly talk relevant? Well, you can’t stop the fact that exchange rates will continue to move up and down every day in a way that is outside of your control, but whilst one movement up or down won’t cause significant volatility on its own, it is still important to prepare for when volatility inevitably happens.
Hedging is used in all kinds of financial markets due to its relative simplicity and its effectiveness in reducing uncertainty and giving you or your business a clear and consistent view of your finances. It works by agreeing to a rate that is then guaranteed for all of your FX trades for a set period of time, usually 12 months. You can use the information at your disposal to inform your decision, such as your previous year’s business in that currency, any purchase orders you have already received or business you’ve already guaranteed. This gives you some much-needed certainty in this volatile time, knowing what rate you will receive for all trades in that currency rather than being subject to the movement of the market.
The most effective way to keep your bottom line safe when dealing with orders and payments abroad is to use an FX specialist. The fact that we can use a forward contract to lock in an exchange rate for you to buy or sell at, means the stresses of currency fluctuations affecting your business will disappear. Our job as FX brokers is straightforward, we mitigate currency risk for your business and make the whole process of foreign exchange as simple as possible.
The true meaning of the butterfly effect is that small things in a complex system may have a massive effect or no effect at all and that it is almost impossible to know which will turn out to be the case. The FX market mirrors this theory which is why it is crucial to ensure that your business isn’t caught out by factors outside of your control.
If you would like to find out more about how we can support your business with its foreign exchange requirements call us today on +44 (0) 20 7738 0777 or click here to open a business account with us.
Posted in Business Resources on Apr 12 2021