The Forex Nitty Gritty

Some Forex traders made money trading the Euro rally that followed positive news about the rescue of banks and remedies for the sovereign debt crisis plaguing the European Union. Others lost as the Euro staged an impressive rally in the EUR/USD pair and in virtually all Euro currency pairs on the news that Germany and France will intervene with sufficient effort to fix the debt crises of its Southern tier states, Greece, Italy, Spain, and Portugal, and Ireland, to so call PIIGS debt crisis. Now that the Euro has turned around and headed up again traders must ask themselves if this is just a brief rally in a generally dismal market for the Euro of if the currency will stabilize. In trading the Euro rally that just occurred traders must think of both fundamentals and technical pricing. The fundamentals are that there is a lot of debt to cover and that continual bailouts of weaker governments by Germany and France, the economic kingpins of the continent, will over serve to weaken the general economic picture and the Euro in the long run. However, traders, and the world in general, are looking for some good news. Those trading options on the falling Euro did well if they were buying calls.

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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It appears as though the best deal last month was investing in the US dollar. Stocks went down, gold plummeted, and interest rates on US Treasuries fell. Meanwhile the US dollar rose in Forex trading in the EUR/USD, USD/YEN, and USD/CHF currencies pairs as well as most others. Investing in the US dollar and US treasuries was an even better deal as progressively lower rates at weekly auctions has raised the value of treasuries in hand. Confidence in the us dollar has risen as confidence in other currencies has fallen. The dollar has traditionally been the safe haven currency of choice although that fact has been called into question in recent years due to the mounting US debt. As the US withdraws from foreign conflicts and uses its military assets more judiciously Europe continues to deal with the debts of its Southern Tier. Greece, Italy, Spain, and Portugal are all dealing with potential debt default as their treasury notes mature. Greece is the constant subject of discussion as severe austerity measures do not appear to be sufficient to meet the requirement of lenders to forgive debt and pay notes coming due.

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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Volatile foreign currency rates are driving Forex traders to the US Dollar – USD. The US congress is back to having problems deciding if it will extend the debt ceiling and Europe is still dallying over a bailout of its struggling members’ debts. Worrying about another dip to the recession the currencies of Asia’s export driven economies are falling among generally volatile foreign currency rates. Versus the US Dollar the British Pound – USD GBP, went down last week as did South Korea’s Won – USD KRW, the India Rupee – USD INR, and the Chinese Yuan – USD CNY. Currency speculators are betting on a continued rise of the US Dollar and the fall of most other currencies. Traders are consulting both fundamentals and Forex technical strategies in order to profit in today’s volatile markets.

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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Put options on the falling Euro – EUR – are the most active that they have been for nearly a decade. The Euro has fallen nearly 5 percent in the last year. With no end in sight to the European Union’s sovereign debt dilemma, Forex options traders have increasingly purchased puts on the EU currency. In purchasing puts in Forex trading the Euro traders purchase the right to sell Euros at the contract or strike price. This can be done in any currency pair containing the Euro. The trader picks a currency which he believes will remain stable or go up in value as the Euro falls. If the trader is correct in his assessment the Euro will continue to fall versus other currency. He then has two choices. He can execute the contract for options on the falling Euro. He sells Euros for US dollars – USD, British Pounds – GBP, Yen – YEN, Canadian dollars – CAD, Australian dollars – AUD, or Swiss francs – CHF, whichever major currency he chose to trade against the Euro. His second choice is to simply exit the options trade by executing the opposite trade on the same currency pair with the same expiration date. This later choice allows him to profit from trading options on the falling Euro without ever purchasing Euros or any other currency.

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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How does China’s plan for internationalization of the Yuan affect Forex traders? China would like the Yuan to be used as an international currency. However, foreign buyers typically pay with their own currencies while foreign suppliers typically are happy to receive Yuan. The Chinese currency has steadily risen against the dollar. The problem for China is that it is increasing its foreign currency reserves at a time when the dollar and Euro are going down in value versus the Yuan. China is losing money on their foreign currency reserves! To a degree the Chinese are at fault for causing this problem. They, like the Japanese and Taiwanese before them, have manipulated their currency, by purchasing dollars, in order to keep their currency weak and the dollar strong. This strategy profits an export driven economy. By keeping the Yuan exchange rate artificially low China has risen to be a global exporter and accumulated massive foreign currency reserves.

Nigeria, a major oil producer and supplier of petroleum to China has just announced that it will begin to add the Yuan to its currency reserves targeting a five percent to ten percent level. This will certainly benefit Nigeria if the Yuan continues to rise in value versus the dollar or Euro. The decision may also be more complicated as China seeks the internationalization of the Yuan. If nations are holding ten percent of their reserves as Yuan and ninety percent as dollars likely not affect the dollar. However, if China discontinues its policy of supporting the dollar at the expense of the Yuan its export situation could suffer. The issue for the trader is how to trade Forex in the event of successful internationalization of the Yuan. Right now the Yuan is really not a market driven currency.

China came out of its self-imposed cocoon years ago and came upon the global economic stage. Its huge, cheap, labor pool was attractive to those who set up factories in China to import back to the world. The huge potential customer base in China was an even bigger attraction to many who were willing to invest and wait for decades for their chance to sell products to an increasingly prosperous Chinese customer base. Now, thirty-nine years after President Nixon’s surprise visit to China opened relations between the two nations, China is looking at internationalization of the Yuan as a step toward a larger role on the world stage. Foreign currency trading of the Yuan versus the dollar may become totally market driven if China gives up its currency controls. Traders will have to follow both fundamental and technical aspects the market at that point in order to profit from trading in a post internationalization of the Yuan era. In the meantime traders are better advised to watch pronouncements of Chinese monetary officials to better anticipate target exchange rates set by the Chinese. As always we are not suggesting that traders trade the Yuan or ignore it. Rather we offer this discussion as an example the thinking traders may go through in approaching a foreign currency.

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Will a Greek bank merger help stabilize the sovereign debt dilemma that has threatened the Euro for more than a year? Eurobank EFG and Alpha, the second and third largest banks in Greece have merged. The result in Greece was that bank shares across the board went up by about a third. What the Greek bank merger might mean for the European Union is a breather from the PIIGS sovereign debt crisis that has plagued the Euro. The two banks have issued new stock and sold assets to raise nearly €4 billion. The Qatari royal family, already shareholders of Alpha Bank, have promised to purchase half a billion Euros of debt with the promise that their investment can be converted into stock in three years. For those Forex trading the Euro a stabilization of Greek debt helped by the Greek bank merger may well be welcome news. On the other hand those who have profited by intermittently shorting the Euro against other currencies may need to look elsewhere for profits.

Good Forex advice in trading the Euro or other currencies is probably to watch the situation to see if the Euro does, indeed, stabilize and start to rise. There are factors besides the debt crisis that have driven the price of the Euro. Economic growth in the Euro failed to meet expectations lately and that has exerted downward pressure on the EU currency. Both sound fundamental analysis and up to date technical analysis are necessary to follow and successfully trade foreign currencies. While the Greek bank merger has made the international news it remains to be see if it will lead to less pressure on Italy, Spain, Portugal, and Ireland, the rest of the PIIGS risky debt group.

The key for the Euro in this situation is that a more stable banking situation in Greece will help keep promises of a sovereign debt bailout from fading away. Commentators remark that it is important that the merger go through and that the currently planned bailout, with its debt reduction agreement stay in place for the sake of Europe’s economic stability. Forex traders will watch this with interest as a solution to the debt crisis could lead to a rally of the Euro. If the deals fall apart the Euro could plummet as we would see an unraveling of sovereign debt across the weaker members of the EU. In the still-volatile PIIGS and Forex situation traders may prefer options trading directly trading the Euro versus other currencies. A simple strategy such as a long straddle will guarantee the trader profits whether the Euro goes up with a debt dilemma resolution or down if the Greek bank merger unravels. If the Euro stays the same the trader will not profit using a long straddle but his losses will be limited to the price of the options premiums paid. As always we are not suggesting that anyone trade the Euro or that anyone ignore the Forex opportunities present in the current situation. We present this discussion as an example of planning in order to set up profits in Forex trading.

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In considering the rise of gold and continuing fall of the dollar we wonder out loud about the relationship between the US dollar and jobs in the USA. The USA has made a science out of sending, or forcing, jobs out of the country. Certainly wages are an issue and companies like to locate where they can pay their workers less. But taxes are an issue too and high corporate tax rates tend to drive business out of the country. The amount of money banked by US multinationals overseas is substantial with companies such as Cisco and Microsoft having somewhere in the range of $50 Billion. There has been talk of a   tax holiday in order to bring some of this cash home to the USA. There has also been talk of forcing these companies to use any tax holiday money to create jobs in the USA. A better means of creating jobs in the USA might well be to improve the long term investment climate instead of taking a piecemeal approach such as one that would apply to a tax holiday for offshore income coming home. The point of all this for Forex traders is that there is, in fact, a strong correction between the US dollar and jobs. Forex traders watch the Non-Farm payroll reports as higher employment tends to lead to a stronger dollar and fewer jobs to weaker dollar. Good Forex advice for traders is to look for signs of increased US employment. A good plan for the US government might well be to consider the relationship between the US dollar and jobs and so structure the tax code and laws of the land that the stronger incentive will be to create and maintain jobs at home.

The US has a double tax system on corporate dividends. Corporate profits are taxed and when paid as dividends are taxed again by shareholders. Capital gains are heavily taxed as well. One of the incentives for investors to buy stocks in some foreign countries is that both corporate taxes and capital gains taxes are substantially less than in the USA. Thus investment capital flees the USA and lands on foreign shores. The dollar goes down and jobs are lost. Looking at the relationship between the US dollar and jobs the US government might consider means of retaining job positions in the USA without another trillion dollar stimulus plan that will simply increase the ever mounting US debt burden. For those who believe that the US will be able to solve the relationship between the US dollar and jobs how to trade Forex successfully may well be to enter long term positions in the dollar. How to trade Forex for those who believe that the US will continue to stagger under a horrendous domestic debt burden may well be to short the dollar and buy Yen, Swiss francs, or even Euros or the British pound. In both cases many traders will likely wish to move in and out of positions rapidly as market volatility increases. As always we are not suggesting that traders buy or sell dollars. Rather our suggestion is that traders carefully evaluate the factors that drive the US dollar and jobs when trading the greenback.

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Recently, slower than expected European growth led to a fall in the Euro. Slower than expected European growth is not the only factor that is weighing on the Euro, however. The European sovereign debt dilemma continues well into its second year. The so called PIIGS crisis involves the threat of government default on debts in Portugal, Ireland, Italy, Greece, and Spain. Greece has taken up most of the news on this subject and recently agreed to extreme austerity measures in return for continued loans from European central banks and independent investors. Portugal has required bailout loans as has Ireland. Most recently Italy was in the news and analysts suggested that if support for Italian debt was not forthcoming that default on Italian bonds could be contagious with many governments defaulting on national debt. Thus the Euro has been up and down over the last two years. The growth of the EU economy has been a positive point in supporting the Euro and now the report of slower than expected European growth has hit the Euro at a bad time. How does the trader succeed at predicting Forex trends in such situations?

For that matter, what does slower than expected European growth have to do with Forex traders? First of all slower growth is still growth. Germany’s economy grew by a percent in the last quarter and overall Euro Zone growth was 2 percent in the last quarter. The concern of many is that the recovery from the recession is cooling off. Chinese industrial production has been off as has been production in North America. Traders looking to the medium to long term are trying to decide which currencies will prosper and which will falter if the world goes into a so called double dip recession. The Swiss franc is at all-time highs and has the Swiss central bank concerned about Swiss currency reserves, whose value is falling in relation to their own currency. In this complex situation it is of interest that despite the downgrade of US debt by the Standard and Poor’s credit rating agency that last week’s auction of US treasuries saw substantial demand and a fall in interest rates to levels not seen for more than two years. The Euro, like the dollar, is a major world currency and is the currency of the first or second largest economy, depending upon whether the US or Europe is in first place. The currency is very like never going to collapse. However, when those in charge of the economies of great nations do not show leadership, as with the dallying over the Greek bailout or the extension of the US debt ceiling it upsets markets.

It would seem that the combination of debt dilemmas and slower than expected European growth have caused a short term change in pricing. It does not, at the current time, imply a long term fall in the Euro. Traders are well advised to watch the next reports of European growth as well as the painfully slow resolution of the PIIGS debt crisis to see how this combination of factors affects Forex trading the Euro.

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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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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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