Market contagion definition
Market contagion is the spread of economic disturbances from one market to another, causing both to fall in value.
It can occur for many different reasons, but from a macro viewpoint contagion happens because almost every market is connected through financial systems. One forex pair can easily link to another, but there are also less obvious correlations between markets – for example, AUD/USD and Silver.
Many markets also use the same goods and services, meaning if one market crashes, it’s likely another will too. When a crash does occur, this interconnectivity between markets causes the initial shock to be magnified.
Contagion is a similar concept to market correlation. However, market correlation doesn’t always negatively impact a market – one market can also benefit from another‘s price movement.
What is domino contagion?
Domino contagion is similar to market contagion, in that one market crashing will lead to another to crash. But with domino contagion, this continues to happen as one ‘domino’ after another falls, which can ultimately blow up into a wider-scale market crash.
Domino contagion is often seen as the actual cause of global financial crashes, as opposed to industries suffering significant, abrupt losses.
For example, in 1997, the Thai government chose to no longer peg the Baht to the US dollar, which completely devalued the local currency. As a result, other East Asian countries suffered similar declines in their currencies and even the stock market was eventually impacted.
Although it can be devastating to economies, domino contagion can provide trading opportunities in forex.