A central bank intervention occurs when a central bank buys (or sells) its currency in the foreign exchange market in order to raise (or lower) its value against another currency.
FOREIGN EXCHANGE INTERVENTIONS BY CENTRAL BANKS: MAIN TALKING POINTS
Central banks often deem it necessary to intervene in the foreign exchange market to protect the value of their national currency. Central banks can achieve this by buying or selling foreign exchange reserves or simply by mentioning that a particular coin is under or over-valued, allowing participants of the forex market to do the rest. This article looks at the different types of central bank interventions and essential facts to keep in mind before trading.
WHAT IS FOREIGN EXCHANGE INTERVENTION?
Foreign exchange intervention is the process whereby a central bank buys or sells foreign currency to stabilize the exchange rate or correct misalignments in the forex market. This is often accompanied by a subsequent adjustment, by the central bank, to the money supply to offset any undesirable knock-on effects in the local economy.
The mechanism mentioned above is referred to as “sterilized intervention” and will be discussed later on, along with the other currency intervention methods.
HOW FOREX TRADERS CAN TRADE A CENTRAL BANK INTERVENTION
Traders must remember that when central banks intervene in the forex market, moves can be highly volatile. Therefore, it is essential to set an appropriate risk to reward ratio and use prudent risk management.
Central banks intervene in the forex market when the current trend is opposite to where the central bank desires the exchange rate to be. Therefore, trading around primary bank intervention is a lot like trading reversals.
Additionally, the forex market tends to anticipate central bank intervention. It is not uncommon to see movements against the long-term trend in the moments leading up to significant bank intervention since there is no guarantee that traders can look for the new trend to emerge before placing a trade.