Traders who wish to trade the Euro, as well as the US dollar, Chinese Yuan, and a number of other currencies will want to keep in mind that everyone is printing money as a remedy to debt, unemployment, and reduced trade numbers. Forex trading and economic news are always intertwined. However, part of the currency trading puzzle is less obvious. As an example, US treasuries are selling at historically low interest rates. It turns out that a major buyer of US treasuries is the US Federal Reserve. This is part of the so called Bernanke Doctrine. Fed chairman Bernanke is considered one of the world’s experts on the causes of the Great Depression. He is applying measures meant to avoid the same sort of devastating economic contraction as happened in the 1930’s. His measures will tend to keep credit flowing, keep interest rates low, and steadily devalue the US dollar. A major aspect of this is that the Fed used recently printed money to buy US treasuries and to purchase other assets. The European Central Bank is following a similar course and China is said to be financing internal construction projects the same way. A Forex trader will see two forces in motion in the case of Euro Zone debt resolution as well as the US economic recovery, more jobs and currency devaluation.

On one hand traders will review how to invest in Euro and on the other hand those seeing the printing presses run at full speed will continue to consider how to short the Euro. Both approaches may be successful but, if so, it will be a matter of timing. In the short term a policy tailored after the Bernanke doctrine coupled with fiscal discipline may well lead to a timely Euro Zone debt resolution. However, a Euro Zone debt resolution purchased by virtue of the printing press will devalue the Euro over time. Then, the third aspect is that a cheaper Euro will make European products more competitive and lead to a stronger European economy and a rebound of the Euro. Forex traders need to stay tuned in to the evolving Euro Zone debt resolution in order gain profits.

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Building booms often precede bad economic times. The “see throughs” in Atlanta and Houston years ago were silent testimony to the hubris of overbuilding during times of loose credit and excessive optimism. (A “see through” is a skyscraper that is largely unoccupied. At sunrise and sunset one can “see through” the many empty floors.) China is said to have over half of the skyscrapers in the world in construction with more on the drawing boards. Even for a large and growing economy that is a lot, especially when financing may be questionable. Property developers in general are pessimistic while construction firms express optimism. One group might be expecting a Chinese real estate crash while the other does not. However, when a construction company finishes the job it gets paid and moves on. It is the developers and investors who suffer when the real estate market crashes. At such times predicting Forex trends can be profitable.

There are three more issues that relate to the danger of a Chinese real estate crash. One is that in an effort to stimulate the economy the Chinese government has built many public projects with hundreds of billions of dollars creating their own artificial boom. The second is the nature of financing in China. Similar to Japan before the bust two decades ago, China has all too many “off the books” loans or at least loans that are not apparent to the general investor. If things go bad they could do so in a hurry with shaky financing. The third aspect is that the Chinese real estate market is already heading down hill. Residential property sales are down substantially in major Chinese cities and sellers are dropping prices in order to get out before things get worse. As the China current account surplus falls so might property values throughout China.

So, what would a Chinese real estate crash mean to the average Forex trader? The global economy is interconnected. Problems in Europe lead to problems in China and problems in the USA lead to problems virtually anywhere in the world. The coming year could be one of extreme volatility of foreign currency rates. The general consensus is that the Euro will fall due to a recession in Europe or a recession avoided by printing money. The seemingly impervious Chinese Yuan could fall as well, or at least level off due to decreased exports. It could get worse if the scenario of a Chinese real estate crash turns out to be the case. Then there is the issue of social and political unrest. The Arab world is not the only place where people have grown tired of heavy handed autocracies. People often put up with bad government when they can put food on the table and rise up when the economy turns bad.

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There is, indeed, speculation that Draghi could find himself following the Fed example of buying government bonds as well. The new bank president has already surprised many by issuing 1% interest loans amounting to over $600 Billion USD to prop up ailing European banks. The end result of all this could well be a yearlong decline in the Euro. Currency traders and others can heartened by the prospect of the EU getting a handle on the debt crisis. Over the long term, a solution to the continental sovereign debt dilemma can only mean good things for the EU. However, it may well be a bumpy and somewhat downward ride for the Euro until the EU gets its house in order. Volatile foreign currency rates were the hallmark of last year and may well continue into 2012. A reduced European Central Bank rate may well lead to a long term solution but at the price of declining Euro in the year or years to come.

If the Euro does decline it will probably not fall all at once or at a steady rate. Trading options on the falling Euro may be the best trading bet. When the trader buys calls or puts on one currency with the other he limits his investment risk to the price of the options contract. Traders will be able to decide upon trades based upon solid fundamental and technical analysis. By purchasing options the trader will be able to avoid substantial losses if his analysis is faulty. On the other hand he will be able to leverage his investment by purchasing options as the cost of an options contract is substantially less than the cost of the underlying currency. As always we are not predicting that the Euro will fall but offering a thought process for traders to follow in developing and executing currency trades. If the impression that Mr. Draghi gives of following in the steps of Mr. Bernanke is correct that will give traders useful insight into the likely direction of the Euro in 2012.

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The expression, carry trade, is usually associated with the Yen and not the Euro. Japan has had extremely low interest rates for two decades. Investors holding Yen can engage in foreign exchange trading and obtain US dollars or other international currencies in search of better returns on investment. Then the investor buys US Treasuries if he now has dollars or, perhaps, Italian or Greek national debt bonds if he has turned in Yen into Euros. Anyone who bought dollars before the rally last fall and then purchased treasury bills before rates fell did doubly well.

On the other hand many Japanese repatriated offshore assets to pay for the destruction of the worst earthquake and tsunami in their history. This Yen repatriation sent the currency up dangerously fast. The rise in the Yen was only halted by threats of the G7 ministers to intervene in strength. Anyone who held offshore assets in a Yen carry trade did poorly at that point. The point of the Yen carry trade is to have or borrow assets in a nation where interest rates are low, convert to another currency, and invest where interest rates are high. The point is also that a change in currency rates does not erase all profits. This is the connection to a so called Euro carry trade.

A concern of some is that struggling European banks that have received 1% interest loans may be tempted to invest in high risk, potentially high return, debt. Whether this would be European debt or to use foreign currency trading in order to practice a Euro carry trade debt elsewhere in the world the potential for profits could be great, providing that the global economic picture brightens. On the other hand the loans could amount to throwing good money after bad if anyone tries such an aggressive and risky strategy. The good news for those fearful of such a scenario is that overnight deposits at the European Central Bank are at an all-time high. Apparently many of the European banks that needed bailouts have learned their lesson. They are avoiding any semblance of a Euro carry trade and putting their short term money in the most secure location available, even at low overnight interest rates.

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News reports tell us that austerity measures demanded by lenders in return for writing of large portions of Greek national debt and securing the rest have evoked street demonstrations and riots in Greece. The Prime Minister recently called for a popular referendum on the painfully cobbled together debt deal offer to Greece. The reaction of many lawmakers is that they will call for a no confidence vote. If this vote passes there will have to be new elections in Greece and all of nearly two years of work putting together a rescue package may indeed go down the drain. A possible result of a Greek debt default would be Greece leaving the European Union and more pressure on other members of the PIIGS group, starting with Italy. The Yen and Swiss franc will likely be under pressure rise farther and the dollar as a safe haven currency will likely go up as well.

What effect will a Greek debt default have on the Euro? What effect will a Greek debt default have on the situation in Italy, Ireland, Portugal, and Spain? How about stock markets throughout the world and other currencies? Many fear a domino effect of debt defaults if the Greek situation is not contained. Certainly markets throughout the world are concerned as every time there is bad news about European debt, stocks go down. Experts are especially concerned that Italy will be next if Greece defaults, with other PIIGS nations to follow. The Euro will likely fall in this case and traders buying puts in Forex trading the Euro will likely prosper. Many choose to buy options in such a situation and avoid trading currencies directly. By doing so the trader limits his risk to the cost of the options contract and enjoys the leverage of trading options as well. Using a strategy known as a long straddle a trader buys calls and puts on the same currency with the same expiration date. He will profit if the currency rises or falls and if the currency rate does not change he will lose only the prices of the options contracts whether there is a Greek debt default or not.

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However, the fundamentals in Europe will eventually change. The situation is driven by the fact that debt instruments in various nations of the PIIGS group (Portugal, Italy, Ireland, Greece, and Spain) are coming due. In Greece, especially, the problem is acute as creditors are demanding severe austerity measures in return for debt forgiveness and debt extension. The value of Greek government notes has fallen drastically. The concern of the Forex markets is that if the Greek government defaults on its debts there will be a ripple effect throughout the EU and even the world. Greece could be forced to withdraw from the EU. The situation will resolve itself for good or for ill. At some point the fundamentals will become less chaotic and less vague and trading of the Euro will pick up again. The downward direction of the Euro will probably stop. Because the majority of trading in Forex markets involves the US dollar an increase in foreign currency trading volume will include the USD. The US dollar could fall versus the Euro in an EU recovery. Traders bullish on the Euro could prosper in such a situation.

There is a sort of fatigue that sets in when markets are constantly chaotic, hard to predict, and unprofitable. Lack of profit and perceived potential for profit is often more important in driving down foreign currency trading volume than the specifics of trading themselves. Forex traders work with a trading strategy. Successful traders back test their results. When they are not making profits and do not understand why, the better choice is to sit on the sidelines until things become more clear. Many traders who stay in the market in such situations use options. For example in trading options on the falling Euro a trader might buy calls on the Euro with dollars. If the debt crisis resolves itself well the Euro will rise and the trader will profit. If the situation worsens the trader has limited his risk to the cost of the options contract.

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While some were making money trading the Euro rally others profited from rising stock markets throughout the world. Traders are looking for stability. We see this in the flight to the dollar of late. Not only have traders been buying dollars and sending the greenback higher but US Treasuries have been selling like hotcakes as well, driving down interest rates and making currently held Treasuries more valuable. In fact the best investments in the last month or so have been secondary market US Treasuries and the US dollar itself. Now, in trading the Euro rally, bearish traders will likely short the Euro while those expecting a European debt solution will likely jump in with both feet and either buy Euros or buy calls on the Euro. Until the Greek debt crisis and possibility of Italian debt default resolve themselves the market will likely remain chaotic.

An advantage of buying options in a chaotic market is that one need never purchase the currencies involved. A trader can buy calls or puts on the Euro with US dollars, Yen, or Swiss francs. If the EUR/USD, EUR/CHF, or EUR/YEN perform as expected the trader can simply execute the opposite trade and exit his position with a profit. He will, of course, have to hold his assets in one currency or the other but need not buy Euros if he trading them versus another currency. Many expect the current rally of the Euro to be short lived. These traders will typically day trade the Euro and get out before the market closes, fearing that breaking news when their market is closed or when they are asleep will be devastating to an established trading position. In trading the Euro rally traders will likely watch technical pricing data more closely than the fundamentals, which are still somewhat unclear. Although both German and French leaders have promised help for banks and the governments of the PIIGS nations there is dissent, especially in Germany, at the suggestion of using German assets to bail out those governments seen as profligate by German voters. In the meantime trading the Euro rally could result in profits, or losses, for those trading in either direction. A successful Forex trading system in this instance could involve use of a strategy such as a long straddle which would allow traders to profit from either upward or downward movement of the Euro against other currencies.

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With the prospect of a second dip to the recession purchases of and futures in industrial raw materials has fallen off roughly ten percent while stocks across the world nearly as badly. The US dollar rose against all major currencies in the last month and several previously stronger minor currencies. That happened for the first time in a number of years. For the quarter the only investment better than investing in the US dollar were US treasuries by 6.4 percent versus 5.7 percent. Part of the rise of the dollar comes from investors seeking the dollar as a safe haven currency. Part is because both Japan and Switzerland have been purchasing other currencies in order to keep the franc and Yen from rising too fast. Forex traders are purchasing dollars because of liquidity as well as the prospect of the currency rising. The Yen and Swiss franc would also be good choices if it were not for the fact that each nation is actively its currency to drive its value down.

Until Europe finds an effective means of dealing with the debt crisis investors and currency traders are going to stay spooked. The flight to quality by investing in the US dollar may be more a flight to liquidity in the face of the Japan and Switzerland driving their currencies down. However, for the time being the dollar is the currency of choice. Fundamentals underlying the dollar include increases in construction and industrial production in the last quarter. The US is not especially dependent upon selling things to Europe – about two percent of exports behind Canada 19 percent Mexico 13 percent, China 7 percent, and Japan 4.7 percent. Also US banks do not have a high degree of exposure to the EU debt crisis. This leaves the USA in a stronger position than others as regards the debt crisis across the Atlantic and Forex risk aversion is driving traders to investing in the US dollar.

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There are two roots to this dilemma. One is the sovereign debt crisis in Europe and the other is the continually mounting US debt. Both situations have traders concerned. Traders for companies doing business internationally are especially concerned as currency risk is a major concern during times of volatile foreign currency rates. International businesses will typically buy currency options in order to hedge currency risk. Trading options on the falling Euro has been profitable for those who purchased puts on the Euro in the EUR USD currency pair. Shorting the Euro also worked but entailed a potentially higher risk. The reason is that in options trading the trader’s risk is limited to the price of the options contract. If currency rates move contrary to expectation the trader can exit the contract at a loss or simply let the contract expire at a loss but that is the limit of his losses. A trader who shorts the Euro, for example, could be hurt if the Euro rebounds after a successful resolution of the EU sovereign debt dilemma. The other advantage of options trading is the leverage it offers traders. A trader need never own either currency. He only needs to buy an options contract and then execute the opposite trade in order to gain his profits when dealing with volatile foreign currency rates.

Volatile foreign currency rates, upward for the dollar, make US assets more valuable. It also makes US products more expensive overseas. In general Asian exporters are interested in a strong dollar but speculators don’t want to get caught in a market of volatile currency rates and falling Asian currencies. In the last week of so several currencies fell versus the dollar. The concern is that a renewed recession in Europe and possibly the USA will dry up the export market for these nations and directly affect their economies. As this situation demonstrates confidence in the dollar is a relative thing. The dollar has generally fallen against many currencies for years. This has led to more successful economies in these export-driven nations. It has also resulted in these nations holding a large amount of US debt. As interest rates fall with successively lower interest rates at Treasury note auctions anyone holding Treasuries has seen an appreciation of about 25% in their investment, a good reason to consider the dollar as a safe haven currency.

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Trading options on the falling Euro has two advantages over simply buying or selling Euros or other foreign currency. Options in Forex exchange trading help traders limit investment risk and allow traders to leverage their investment capital as well. When a trader buys put or call options on the falling Euro, for example, his only risk is the price he pays for the options contract. If currency rates to not perform as expected the trader limits his losses. If a currency trader buys out of the money puts or calls on one currency with the other he can often enter a trade at a very low cost. He does not invest the price of the currency involved, only the premium for his options contract. Should the currency pair perform as expected traders can earn multiples of their Forex options investment.

As put options on the falling Euro outnumber calls interest rates on government bonds in both Greece and Italy are rising. These two nations are part of the PIIGS group, Portugal, Italy, Ireland, Greece, and Spain, whose national debt issues have plagued the Euro for well over a year. The underlying concern is that Greece and then Italy will default on their national debt and that the stronger members of the EU as well as the EU central bank will not intervene sufficiently to stop a wave of sovereign debt defaults reaching beyond the EU. Trading volatility is high as traders seek to profit from this unfolding drama. Buying options on the falling Euro can be considered a safer bet in a volatile market than selling options. The risk in selling puts, for example, can be essentially bottomless if the downward direction of the Euro, or any currency, accelerates.

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