The Forex Nitty Gritty

Predicting Forex trends is often the key to how to trade Forex. In this case we are not talking about minute by minute or hour by hour variations in the Forex markets. Rather we are talking about large shifts in the relative values of various currency pairs that take place over weeks, months, and years. Accurately predicting Forex trends can result in substantial gains in trading currencies directly or trading via the futures or options markets for foreign currencies. A lot of attention these days is given to the Euro and the US dollar because of the twin debt crises on opposite sides of the Atlantic. Both currencies are weighed down by the size of their debts and the consequent fallout onto both of their economies. In predicting Forex trends many choose to believe that the Euro and US dollar will both continue their gradual slides in relation to other currencies. For example, trading in Asian currencies and the Australian dollar in relation to the US dollar has be active of late as traders exit US dollar positions in favor of the Aussie, Yen, Yuan, Rupee, Taiwanese dollar, or Singapore dollar.

In predicting Forex trends a trader is well advised to consider the effects of a rise or fall of a currency on its nation’s economy. Japan is a case in point right now. A recent rise in the Yen was coupled with a fall in a number of Japanese stocks. The fact is that Japan wrote the book on supporting the US dollar in order to make their products economically competitive in US markets. As the Yen goes up so does the price of products manufactured in Japan and exported to the USA or Europe. Over the long term a steady devaluation of the US dollar and Euro will result in fewer sales of Japanese, Chinese, Taiwanese, and other Asian products to the world’s two most lucrative consumer markets, North America and the European Union. Although Japan’s ongoing monetary policy is to support dollar it could become too costly in light of the reconstruction costs in Japan after the earthquake and tsunami. The amount of Yen repatriation after the earthquake helped to drive to price of the Yen up as well. The economic effects of a rise in Asian currencies could work, later on, to support the dollar and Euro.

Things have a way of balancing themselves out in the Forex markets. Traders have tendency to drive prices based upon the short term. Companies doing business internationally seek to protect profits by trading Forex, especially with options. Thus Forex trading and foreign currency risk are closely connected. A US company that purchases machine parts from a German company concerns itself with the relative values of the dollar and Euro over the term of the contract for payment and will trade accordingly. These traders may be fully capable of predicting Forex trends in the longer term but do not concern themselves with the long term in their day to day trading. Thus the market may seem to have a rather short focus. In predicting Forex trends over the longer term a trader needs to do his own fundamental and technical analysis based upon his own time horizon.

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Daily foreign exchange trading volume has more than tripled in the last decade to roughly $4 Trillion US. Much of the increase comes from speculators in currency markets, especially individuals taking advantage of online Forex trading. Online foreign exchange trading allows traders to buy and sell foreign currencies virtually around the clock on all business days. The major currency markets are London, New York, and Tokyo. How to trade Forex starts with opening a trading account and obtaining software compatible with that of a broker. Then any person with sufficient capital can engage in foreign exchange trading. The US dollar is part of over 80% of trades and the vast majority of all trades are between the major currencies which are as follows:

United States Dollar – USD

Euro – EUR

British Pound – GBP

Japanese Yen – JPY

Swiss franc – CHF

Canadian Dollar – CAD

Australian Dollar – AUD

Foreign exchange trading can be lucrative and foreign exchange trading can be financially disastrous. Would be traders need to learn the fundamentals that drive Forex markets and develop Forex technical strategies that lead to profits. Like all business endeavors there is a high rate of failure in the early months and years. The problem for the beginning trader is that he is always trading against professionals with years of experience and substantial research experience. As hedge funds and other new investors enter into foreign exchange trading they bring with them or hire professionals who map market trends and develop increasingly sophisticated computer programs to anticipate market movement and execute split second trades. The backbone of foreign currency trading is comprised of the international companies and banks that exchange currencies as part of their business. These companies often engage in options trading in order to hedge currency risk and have decades of experience in reading the Forex markets.

Professional Forex trading operations typically have a host of professionals at every level of trading, strategic development, and IT in order to develop and execute successfully. While the beginning Forex investor is simply wondering how to trade currency an institutional trader will be using complicated algorithms to profit from the volatility of the Euro in the face of an ever growing debt crisis. Traders will develop dozens of trading models and then test and compare with historic trading data. The beginning investor can do the same but does not have the “horse power” to keep up with the large operations. The flip side is that an individual trader does not need to enter into every possible trade. He does not need a steady income stream to pay the salaries or dozens of support personnel. An individual trader has the option to follow the currency pair or pairs of his choice and execute the occasional, hopefully profitable, trade based upon clear and compelling data and reasoning. A common means of limiting investment risk and also leveraging investment capital is to buy options in foreign exchange trading. A trader buys puts in order to profit from a down turn in a currency he owns and calls to profit from an upturn in a currency he wishes to buy. His investment risk is limited to the premium paid and he has the potential for a multiple return on investment.

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Is worry about Italian debt default next on the Forex agenda? As the Greek debt crisis lingers it is like an infectious disease that is spreading across the Euro Zone. The so called PIIGS debt crisis has plagued the European Community and repeatedly driven the Euro lower. As talks about debt relief for Portugal and, especially, Greece drag on the Forex markets are worried. If the EU does not respond decisively in the Greek and Portuguese situations an Italian debt default is a possibility. Debt of these nations is held by variety of investors, some private, and some governmental. The Japanese are regular investors in Euro denominated and US dollar denominated debt. This is because Japanese interest rates have been at near zero for two decades. Japanese investors practice a “carry trade” in Yen. They take savings that could have been invested in Japan and move them overseas to the USA or Europe by purchasing dollars or Euros. Then they invest. For example they buy government bonds which pay an attractive rate of interest. However, when these bonds come due investors worry that the Italian government, in this case, or the Greek government will not pay back their principal. This adds an Italian debt default to a Greek default on the investor’s list of worries.

The Euro stands near an all-time low against the Swiss franc and has fallen versus the dollar as fears of a spreading debt crisis engulf the currency markets. With this crisis as a backdrop, members of the European Commission, the European Central Bank, and the European Council are meeting. The problem for the ministers is that the longer they take to come up with a solution the crisis in Greece the more time traders have to worry about the debt crisis spreading. Then traders who are worried about an Italian debt default exit their positions in Euros, further driving down the continental currency. The burden on European central banks includes the increasing financing costs associated with increasingly less attractive debt. Those Forex trading the Euro will take the actions and pronouncements of these central banks seriously in choosing their Euro trades.

Many foreign investors such as the Japanese are currently selling their Italian bonds and converting the proceeds out of Euros into Yen, dollars, or Swiss francs. Whether they see the dollar as a safe haven currency in this situation or simply want more reliable investments in the USA the net result is to drive down the price of the Euro. One factor preventing a free fall of the Euro versus the green back is the ongoing cat fight between the US congress and the administration regarding US sovereign debt. If the US does not increase it debt ceiling Forex traders will be worried about a default that would make Italian debt default look tiny in comparison. If the parties involved in US talks simply agree to increase the debt ceiling again they will reassure Forex investors in the short term. However, no one is fooled into thinking that the US can continue to heap debt upon debt and not reap the consequences in a steady slide of the US dollar versus all of the currencies of the world.

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A pertinent question among Forex traders today is, “Why is the dollar climbing?” There have been a number of reasons why the dollar has fallen of late. The US Federal Reserve has been following a policy intended to promote investment and create jobs. As such interest rates have been kept low. When asked about this, the Fed as responded that it is less concerned about inflation than with stifling the economic recovery. Why has the dollar faltered in relation to the Euro? Forex investors have looked outside of the US with its low interest rates for profits to places such as the European Union and the Euro for higher interest rates. As the Euro has faltered due to the persistent Greek debt crisis this strategy has backfired on many Forex traders. So, why is the dollar climbing? Is it just because the Euro is having problems?

An interesting event may well be the fact that US multinationals are said to be bringing profits home to the USA. This could be related to their collective belief that the dollar will soon rally. Whatever the reason the effect on the dollar could well be similar to what happen with Yen repatriation when Japanese companies brought home Yen to deal with the after effects of the earthquake and tsunami. If, in fact, US multinationals bring profits home to the USA the purchase of dollar with the various currencies of the world will drive up the price of the dollar. Traders can successfully anticipate this situation in two ways. By engaging to continual analysis of the dollar traders will stay current on US monetary policy. They will be aware of companies beginning to purchase dollars. By following technical pricing patterns traders will not need to ask, why is the dollar climbing? They will simply trade according to market patterns and pocket their profits.

We may ask why is the dollar climbing when we hear of huge debt problems in the US as well as solid growth in other economies over the last couple of years. One of the issues of the years has been the lack of transparency in many economies. An example is the strength of the Japanese economy and the Yen during the 1980’s. The Yen was strong and the Japanese industrial machine, seemingly, could do no wrong. Japanese investors were buying US assets from Colombia pictures on the West Coast to Rockefeller Center in New York City. Shortly after these well published purchases it became apparent that there were problems in Japan. Much high level lending in Japan took place based upon handshakes and old school relationships. Encouraged by the government loans were made to support new industry and business even when these were not especially profitable. When this became known the proverbial house of cards came tumbling down. Japan has languished with near zero percent interest rates for twenty years as a result. The country has remained prosperous but the myth of invincibility was busted and the Yen did not go on to become the world’s dominant currency. During this time many have continued to view the dollar as a safe haven currency. So, why is the dollar climbing? As always it has to do with a variety of factors but in the end it means that folks want to buy dollars and will pay a higher price.

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A currency ETF or Exchange Traded Fund is a fund that deals in one national currency. A currency ETF can hold assets in any of the world’s currencies. Such funds offer investors and traders a focus on an individual nation and economy. A currency ETF offers benefits similar to single country stock funds. Currency traders following the Greek debt crisis and the travails of the Euro might be interested in a currency ETF that holds only Euros. A plausible strategy might be that when the Greek debt crisis, specifically, and, in general, the PIIGS debt crisis including Portugal, Italy, Ireland, and Spain is resolved the Euro might rebound sharply. An alternative could be a currency ETF dealing in Yen. The same sort of strategy would prevail in that the trader would believe that the Yen will go up substantially when the short and midterm effects of the earthquake and tsunami are dealt with.

Currency ETFs are a current hot item. It remains to be seen if a currency ETF is a better investment than simply trading the country’s currency by oneself. Many believe that an ETF focused on equities in a country is a better tool with which to profit from economic events. An ETF can simply hold a currency or it can trade the currency, typically versus the US dollar. A currency ETF that trades in any of the major currencies can trade against any of the other major currencies. However, many minor currencies only trade versus the US dollar. As such one might think of a currency ETF for a minor currency as also being a currency ETF for the US dollar or perhaps its reciprocal. Whether traders in an ETF are dealing in the post tsunami Yen or any other currency the skill of the traders will likely be more important than the particular currency which they are trading. If the ETF is of the “buy and hold” variety the choice of currency will be more important than choice of trader. However, the investor will be foregoing the profits available in Forex trading that come from the daily fluctuations in currency rates while waiting for an eventual big market move.

Investing in a currency ETF or an ETF that invests solely in one nation’s stocks has both an averaging effect and an exclusion effect and both can be detrimental to the investor. If one chooses to follow the fortunes of a single currency one may well have tied up all of one’s investment capital just when there is a big and promising market move in another currency pair. For a stock fund in one country one must remember that not all stocks perform equally, just like not all currency pairs perform equally. Picking the right stock can be more important than picking the right country. Picking when to trade the Euro, Yen, Rupee, Ruble, Real, and others can be more profitable than solely focusing on one currency to the exclusion of all others. A currency ETF can be like long term, buy and hold, investing. It can gain profits, or losses, and it can tie up investor capital to the exclusion of other opportunities.

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