3 Behavioural Economics Themes Shaping Forex Rates

Have you ever had the impression that trading in the forex market could turn into a rollercoaster? It has nothing to do with monitoring funds’ interest rates, inflation, or events that stir up currency transformations. The second side towards it is more of our own perceiving and experiencing of reality. This is where behavioral economics fits in- this is all about the ‘choices’ we make as marketers. 

For those of us who deal with sending money across borders, grasping these psychological insights can be a game-changer. Let’s dive into three key concepts that really influence forex rates in India: the way we tend to follow the crowd (herd behavior), how we latch onto initial information (anchoring), and our tendency to fear losses more than we value gains (loss aversion).

What is Behavioral Economics?

Behavioral economics is an intriguing field that blends psychology and economics to shed light on how people really make decisions. Unlike traditional economics, which often assumes we’re all perfectly rational actors making the best choices for ourselves, behavioral economics recognizes that our decisions are frequently swayed by cognitive biases and emotions. This discipline delves into how these biases and behaviors influence our economic choices, the outcomes in markets, and even the fluctuations in currency values within the Forex market.

Behavioral economics looks for and analyzes things like overconfidence, fear, and social trends, which in turn are different from what a rational economic model would suggest. Thus, studying such patterns enables us to have a clearer vision of the market patterns that help us better understand shifts and respond to them in the future.

1. Herd Behavior

Herd behavior happens when people follow the actions of others instead of doing their own research. This can lead to rapid and significant changes in currency values that often don’t reflect the underlying economic reality.

For instance: Indian Demonetization (2016)

Remember back on November 8, 2016, when India suddenly declared ₹500 and ₹1,000 notes invalid? It caused quite a stir, right? People panicked, and that panic spread quickly—classic herd behavior. In the forex market, everyone was trying to figure out what this meant for the economy. The Indian Rupee (INR) became really volatile. The USD/INR rate shot up from around 66 to 68.5 in no time because everyone was reacting at once.

2. Anchoring

Anchoring happens when people fixate on the first bit of information they get (like an “anchor”) and let it influence their decisions too much. In forex trading, this means traders might stick to old exchange rates or initial data, even if things have changed a lot since then.

For instance: USD/INR Exchange Rate Stability (2013-2015)

Consider the USD/INR exchange rate during 2013-2015. Traders often anchor their expectations based on historical stability around 60-62 levels. Even as India’s economic policies and global market conditions changed, anchored expectations caused slower adjustments to new realities. When the Reserve Bank of India (RBI) initiated policy changes in response to global economic shifts, the exchange rate did not immediately reflect these changes due to traders’ anchoring bias.

3. Loss Aversion

Imagine how it feels when you lose money, it stings way more than the happiness of making the same amount. That’s what loss aversion is all about. In Forex trading, this often means traders can’t let go of bad trades. They hang on, hoping things will get better, instead of just accepting the loss and moving on. It’s like they’re paralyzed by the fear of losing, even when it would be smarter to cut their losses and start fresh.

For instance: Indian Rupee Depreciation (2018)

Back in 2018, the Indian Rupee took a big hit and dropped to a record low against the US Dollar. Even though there were clear signs that things would keep getting worse because of rising oil prices and global trade tensions, a lot of investors just couldn’t let go. They held onto their rupee positions, hoping things would turn around. This loss aversion kept the market from correcting itself quickly, and the rupee stayed weak for a longer time.

Conclusion

Understanding the human psychology behind Forex market movements through behavioral economics can provide cross-border remittance providers with a strategic edge. By delving into concepts like herd behavior, anchoring, and loss aversion, these providers can enhance their approach to currency management, ultimately boosting their competitive advantage, service reliability, and customer satisfaction.

At moneyHOP, our mission is to simplify the process of sending money abroad. Our deep expertise in the forex markets ensures we offer the best rates and exceptional service. Interested in how we can assist with your overseas education remittance? Reach out to us today!