The Forex Nitty Gritty

Interest rates and Forex are commonly intertwined. Investors will commonly move assets to currencies that pay higher interest rates. Japanese interest rates and Forex trading of the Yen were a case in point for years as many practiced the Yen carry trade. The idea was to borrow money in Japan at extremely low interest rates and use the borrowed Yen to buy dollars, Euros, Swiss francs, British pounds, Australian dollars, or Canadian dollars. Then the investor used his new currency to buy US treasury bills or enter into some other higher interest paying investment. We saw the flip side of the using of interest rates and Forex trading when Japanese companies and individuals began Yen repatriation in order to pay for the costs of dealing with the historic earthquake in that country.

Using interest rates and Forex trading to profit is common and does not require the Yen carry trade or any variation. Countries where government bonds, corporate bonds, and banks pay high interest rates often attract foreign capital. When investors use their currency to buy the currency of the country with higher rates they drive up the price of the other currency. Forex traders can profit from this situation merely by trading Forex. They do not need to make investments in the other country. How to trade Forex and interest rates is simply keeping an eye on the technical and fundamental factors that tend to predict changes in interest rates in order to buy and sell foreign currencies.

A current example of how Forex and interest rates relate is the fact that recently the Euro strengthened on the assumption that the EU will be raising interest rates. Although it is investors buying Euros that drive the price up traders speculating on the price of the Euro in other currencies play their part as well. Investors as well as traders will drive up the price of the Euro so long as buying is likely to lead to profits. For the investor it has to do with whether the rise in the Euro makes buying it prohibitive. For the trader it simply has to do with how the market is likely to react and where prices will turn around. Because central banks are instrumental in setting interest rates the actions of the US Federal Reserve and central banks such as that of Japan are watched carefully by Forex traders. Just as the Federal Reserve buying gold and currency can affect Forex trading so are Forex and interest rates set by the Fed crucial to trading the dollar. An overriding factor now in the Forex markets is the Yen and the draw down of Japanese offshore assets. However, that situation will eventually stabilize and traders will resume their normal routine of watching the pronouncements of the Fed and various central banks to help predict just where interest rates are heading. Interest rates and Forex are always related and those who most accurately predict where rates are going have a distinct advantage in the Forex markets.

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The recent rise in the price of the Yen has been largely blamed on Yen repatriation by Japanese companies bringing assets back home to deal with the costs of the terrible earthquake and tsunami. As Japanese insurance companies engaged in Yen repatriation to cover expected the costs of insurance benefits, G7 ministers and central bankers announced their intention to keep the Yen from going too high. In order to maintain orderly foreign exchange markets these agencies announced the intention of currency market intervention. As is often the case the mere threat of invention often turns the Forex market. Although Yen repatriation certainly continues it appears to be happening without driving the Yen to further highs. How to trade Forex successfully depends upon understanding what drives currency prices. Thus, a little insight into Yen repatriation is in order. What is happening is that much of the Yen carry trade has been done by Japanese unwilling to put their money in Japanese bank accounts where interest rates are nil. Thus these folks have bought US treasuries or other foreign debt instruments in order to gain a higher rate of interest. Now, when they need to bring assets home these investors need to sell offshore assets and convert their dollars, Euros, Swiss francs, and British pounds back into Yen. The buying pressure on the Yen has driven the price up.

The problem for Japan with a higher priced Yen is that Japan is an export driven economy. If the Yen is expensive so are Japanese products. High priced Japanese products could make them less competitive with similar products made in other countries. Thus Japan’s economy would suffer from a stronger Yen. Also, for those trying to bring assets back home, a stronger Yen makes their offshore assets less valuable. This has always been the risk of the Yen carry trade. So long as currency rates remain reasonably stable it is easy to bring assets back home to Japan. When the Yen raises greatly in value the investor may lose more money in the exchange rate change than he has gained in several years of holding offshore debt instruments. How to trade Forex today with the Yen versus any other currency is to be aware of the issue of Yen repatriation.

There are, as always, other factors other than Yen repatriation that drive the currency markets today. One is outright war in Libya as well as political unrest in several countries in North Africa and the Middle East. These events tend to drive investors to safe haven currencies. We typically see the dollar as a safe haven currency along with the Yen and Swiss franc. The problem for the dollar today is that much of the Yen repatriation or Japanese asset repatriation is coming out of T Bills and the US dollar. As such the dollar may fall in value even as some investors move to it as a safe haven. As usual we are not suggesting that Forex traders buy or sell Yen, dollars, or any other currency. The point of this discussion is to highlight the factors that tend to drive currency prices and to encourage readers to understand the fundamentals of the currencies that they trade and the technical factors that drive market sentiment.

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What will happen to the post tsunami Yen? A disaster of Biblical proportions has befallen Japan. Nuclear plants are in danger of meltdown. Trading is halted again and again on stock exchanges in Japan as prices plummet. Much of the Northeast of Japan enters its fifth day without electricity and fresh water. All of this happens in the aftermath of the worst earthquake to hit Japan in known history. The 8.9 quake on the Richter scale caused a tsunami that washed boats, houses, and cars before it as it rushed inland. Published photos of the aftermath are truly horrifying. There is an understandable urge on the part of many to either shut the images out or our minds or to focus entirely on the immediate humanitarian dilemma of so many people. However, for those entrusted with carrying on the work of the world despite such obstacles one issue will be the state of the post tsunami Yen. It may seem incorrect to be thinking of Forex technical strategies at a time when so many are suffering. But, for those doing business with Japanese companies, such as selling American grain and other food stuffs to the Japanese market it is essential to deal with the issues that will drag the Yen down or raise it up.

Prior to this terrible natural disaster Japan has gone through a period of relative economic stagnation. This situation was preceded by a nearly unrivaled economic boom during the decade preceding 1990. At that time Japanese companies were buying assets throughout the world using a high priced Yen. When the problems of Japan’s banking system came to light their strong economy did not collapse but went stagnant. Its companies continued to supply the world with products but the low interest rates that Japan used as economic stimulus made the Yen the focus of an international carry trade. Now where will the post tsunami Yen go? For this we should look at the factors that will directly affect the Yen and the factors that will affect competing currencies. For example, factors that have caused the downward direction of the Euro will not go away because of Japan’s misfortunes. The USA will not suddenly resolve its national debt problems either.

How to trade Forex successfully is always to understand the fundamentals that drive the price of a currency in relation to others and to understand the technical factors the make the market fluctuate. The fundamentals are very grim right now in Japan. There is the specter of nuclear power plants melting down and releasing radiation. Whether the situation gets that bad or not damage to the several plants currently in the news could threaten the ability of Japan to generate electric power. This could cause rolling blackouts and reduce industrial production. With reduced industrial output the post tsunami Yen could suffer. The other side of this is that in this world of integrated economies when the third largest falters the effects will be felt elsewhere. Japan is a big consumer of products produced elsewhere and has a $300 Billion USD bilateral trade with China. What will happen to the Yuan as a result of the same factors that drive the post tsunami Yen? The point of this is that in order understand and trade the Yen in this situation the trader needs to follow fundamentals and technical factors closely. Using options trading will probably be a wise idea in order to contain risk. Speculators will be able to sit out the trading if the situation becomes to uncertain but those assigned the job of hedging currency risk in trading with Japan will need to stay the course.

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To take the most advantage of foreign currency trading opportunities a trader will want to know how to build a trading plan for Forex. Knowing how to build a trading plan for Forex, doing so, and reviewing the plan, as needed, will put the trader where the most profit is. There are several aspects to how to trade Forex. The beginning trader obviously needs to learn the basics about how the market works. He will need to choose which market to trade in and which currency pair or pairs he will want to trade. What are the most popular Forex trades today? The US dollar appears in over 80% of trades. The vast majority of traders stick with the major currency pairs. However, there is typically not a lot of profit to be made in trading a sideways moving market. Traders never lose money if they just sit out a trading session instead of chasing profits that just are not there. On the other hand a trader can subscribe to a service that alerts him to trading action and Forex news outside of the currency pair that he normally trades. How to build a trading plan for Forex that spots where the profit might be, is to subscribe to a service that keeps up with the entire market.

How to build a trading plan for Forex includes the basics of getting the job done. A trader does not spend all of his time at the trade station. He may spend time reading the Forex news. He may subscribe to chat rooms or coaching services in order to pick up trading tips and hone his skills. A wise trader will practice in simulation when he plans any changes in his tactics and strategy. How to build a trading plan for Forex obviously includes time management as well as the specifics of day trading at the trade station. A practical consideration in picking which major market to trade may have to do with which currencies are more commonly traded there and if that market is in the same time zone as the currencies that one trades. For example a trader who commonly trades the Euro versus the British Pound or Swiss francs may choose to trade the London market as the market will be open as pertinent Forex news breaks. A trader who trades the Yen versus any other currency may choose to trade the Tokyo market for similar reason. Because the USD dollar is used in over 80% of trades the New York market is a logical choice for many. However, not all traders can trade Forex full time. Many have day jobs and trade in evening hours. Thus practical time considerations may have more to do with which market one trades than other tactical considerations. Forex technical strategies may be the most important aspect of trading and how to build a trading plan for Forex. Because technical trading works most efficiently in high volume trading that is why so many build their Forex trading plans around the major currencies.

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When the world descends into chaos the foreign currency markets become more volatile. Knowing how to measure Forex volatility is useful in that it gives the trader insight into the currency pair or pairs he is trading. Knowing how to measure Forex volatility goes hand in hand with basic technical analysis of market sentiment is seen in price patterns. Forex volatility can be measured in pips or as a percent. It is simply the difference between the high and the low price of one currency in relation to another. It can be stated for a day, week, month or any time frame. Pips are the smallest unit change by which a currency can be quoted. For pairs including the US dollar a pip is $0.0001 or a hundredth of a cent. When the price of the dollar versus the Euro varies by half a cent in a day the volatility is 50 pips. Measured in percent it is 0.5%. More statistically based measures use the standard deviation and more complicated measures. How to measure Forex volatility for the less mathematically inclined is to stick with pips and percents. There are charts available on the internet that will do the more serious mathematical calculations for you. In learning how to trade Forex a trader will want a basic sense of how volatile the market is and what that means for profit versus risk.

Many Forex technical strategies relate to market volatility. If a currency pair is trading in high volume technical analysis tools typically work better as they are based on statistics. During times of market upheaval, such as we are now seeing due to the unrest across North Africa and the Middle East, traders look to profit from anticipating price direction. When volatility is high many will rely upon buying options, puts and calls, because the buyer of an option only risks the price of the option, the premium. Even though his risk is low due to buying options the trader will have the right, but no obligation, to purchase or sell one currency with the other and profit should the price move as anticipated. Today many currencies are under stress due to the risk of a large upward movement in the price of oil. Typically this means that traders will move to the dollar as a safe haven currency. However, the US views inflation as more of a risk than unemployment at this point and is keeping interest rates low. If the EU or Great Britain, for example, raise their rates traders will move money into the currency with the higher rate, driving up the value of that currency and driving the dollar down. Traders will often buy futures on the Euro or dollar or options in anticipation of changes in monetary policy and continuing volatility. How to measure Forex volatility in these times is a useful skill as it can allow the trader to formulate and execute a successful Forex trading strategy no matter where the markets are going as it helps him decide on strategy, such as direct trading versus options and upon which currency pairs to trade.

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