The Forex Nitty Gritty

New headlines about a government collapse indicate that a Greek debt default is very possible despite herculean efforts by the European Community at large to prevent this very scenario. This story goes back a couple of years to the 2008 stock market crash and onset of the worst recession in three quarters of a century. Nations throughout the world borrowed heavily, or simply printed money, to avoid a banking collapse and a much dreaded freeze in credit worldwide. This strategy has been criticized by some as likely bankrupt many nations and lauded by some as having avoided a second Great Depression. The result in a number of nations in the European Union is that banks stayed open and governments engaged in various economic stimulus plans in efforts to jump start their economies. However, the end result for several nations was that they simply ran out of money and credit. The looming Greek debt is not the only sovereign debt issue plaguing Europe. Five nations have been in the spotlight for the last years. Portugal, Ireland, Italy, Greece, and Spain have become known as the PIIGS group in financial circles. As things worsen Forex risk aversion has driven the Euro down.

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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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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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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Mexican currency exchange rates are no longer just a concern for tourists. Mexican currency exchange rates have become an issue for currency traders as the world of emerging market currencies collides with high tech trading. The Mexican peso is actively traded in the world of emerging market currencies. How to trade Forex today with the Peso, for some, is by arbitrage between the CME and the Mexican exchange MexDer. The Mexican exchange is increasing its bandwidth and level of connection with the CME in order to allow for this degree of trading in thousandths of a second. What attracts traders to Mexican currency exchange rates or those of the Thai baht, Indonesian rupiah, or Singapore dollar is their relative volatility. This volatility in emerging market currencies is that promises large profits. Trades need to remember that large volatility can also lead to large losses.

In trading Mexican currency exchange rates the trader will follow the same sort of economic news, monetary policy, interest rates, and political factors that traders follow when trading all currency pairs. The North American Free Trade Agreement has slowly but surely increased prosperity and growth of the middle class in Northern Mexico and throughout the country. As prosperity goes in Mexico so will, likely, the health of the Peso. It has always been possible to trade the Peso versus the Dollar. However, the addition of emerging market currencies such as the Mexican Peso to the list of possible currencies to trade with high tech tools could be profitable for both institutional and independent traders. As trading volume of the Peso increases so will the accuracy of Forex technical strategies in trading Mexican currency exchange rates.

Forex trading and the economic news is as important a relationship when trading Mexican currency rates as it is for trading the dollar. The Mexican central bank recently kept its key interest rate at 4.5% for the 22nd consecutive month which helped the Peso rise slightly against the dollar. Although the direction of the Peso may well be upwards over time as the Mexican economy strengthens it is not so much the long term view of the Peso that interests traders as the day by day fluctuations in the currency. With the advent of high tech trading of emerging market currencies such as the Mexican Peso there will be more profits to be made and more risk of loss for the trader. For the international business interested in trading across borders the ability to trade directly in emerging market currencies will be helpful. Currently many emerging market currencies only trade with the US dollar. Thus to convert a currency such as the Mexican Peso with the Thai baht is has historically only be possible by trading one with the dollar and then the dollar with the other. It is possible that with higher volume currency trading in emerging market currencies that it will be possible to trade one directly with another, which might serve to foster increased trade and prosperity as well as foster more interest in Mexican currency exchange rates.

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The Euro and bailing out Portugal are in the Forex News. So is the arrest of a French presidential hopeful in New York on sexual assault charges. Speculation on the Euro and bailing out Portugal has become hotter in light of the absence of International Monetary Fund chief Dominique Strauss-Kahn from last minute negotiations. Strauss-Kahn has been considered a more flexible member of the IMF and has been a leader in recent years in helping cope with the effects of the world wide recession on currency values. He was, in fact, considered a strong prospect for becoming the next president of France. PIIGS and Forex have been in the news for over a year when news broke that several members of the European Community had worse than expected sovereign debt issues. Portugal, Italy, Ireland, Greece, and Spain became the PIIGS. The Euro has fallen and risen as this drama has played itself out. Now the Euro and bailing out Portugal are on the front page. There is a push from some to force Portugal to privatize industries and for private sources to become more involved in helping relieve the Portuguese debt burden. Here is apparently where the absence of Dominique Strauss-Kahn will be felt in last minute negotiations to bring about a quick and effective solution to helping the Euro and bailing out Portugal.

Insiders have been quoted to say that things are far enough along in the current bailout that Strauss-Kahn will not be missed. However, the flavor that his presence adds to discussions has tended to lead to a pro growth stance among ministers. This may be missed if current events in New York lead to his leaving the IMF or for that matter French politics. For those interested in trading matters of the Euro and bailing out Portugal options are always useful in that buying puts or calls on the Euro limits investment risk while preserving the opportunity to profit if the Euro moves as expected during or after a bailout of Portuguese national debt. Many credit the survival of many economies in the current financial crisis to the presence of Chairman Bernanke on the US Federal Reserve. His previous research demonstrating that a tightening of credit was largely responsible for turning the economic down turn of the early 1930s into the Great Depression. While Forex technical strategies are important in trading currencies such as the Euro today the major players are fundamental to the equation. If a progressive such as Strauss-Kahn is removed from the picture some worry that a tightening of credit and a slowing of the recovery could be possible.

His absence from the top rank of IMF decision-making is not expected to affect any of the bailouts in the short term, but could have an impact in the longer term if it leads to a change in the nature and style of the IMF’s involvement.

Strauss-Kahn, who has been at the IMF for nearly four years, is seen as having made the organization less doctrinaire when it comes to providing assistance to struggling sovereign countries, leading it to take a less strict, more pro-growth stance.

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Forex risk aversion helped the Swiss franc and Yen rise recently. What is Forex risk aversion? Risk aversion is when traders buy Yen, Swiss francs, or the dollar as a safe haven currency. Traders and investors see other currencies as risky and choose to move assets into currencies of countries that are economically stable. Traders seek currencies that are likely to rise in relation to others, not because of their own strength so much as because of the weakness of other currencies. At the current time the Swiss franc and the Yen are seen as safe haven currencies for those with Forex risk aversion. The US dollar is currently seen as less of a safe haven due to mounting debt problems of the USA. A congressional showdown that temporarily left repayment of US debts in doubt did little to help matters. Although Chinese support of Spanish debt has helped the Euro recently it fell off of the safe haven list some time ago.

There are both long term and short term Forex risk aversion strategies. A long term strategy is to stay away from falling currencies such as the dollar and Euro. A commonly more profitable Forex risk aversion strategy is to move into safe haven currencies in times of stress and out just before ailing currencies recover. The US dollar, fore example, has been declared down and out several times over the years. Those who have doubted the demise of the greenback have often profited by buying dollars as they bottom out. Another profitable way to play a Forex risk aversion strategy is to move into a strong currency like the Swiss franc when a crisis looms. Then the trader can buy calls on dollars, Euros or his currency of choice. When the faltering currency recovers, the trader profits. How to build a trading plan for Forex today can be to simply buy Yen or francs and hold them. A more profitable strategy will be to acknowledge that currencies can vary substantially in value and that anticipation of price movement is where the profit is.

Although Forex risk aversion can drive investors to buy Yen, the recent earthquake and tsunami in Japan occasioned another move. The rush by Japanese to return assets home to deal with the cost of the natural disaster caused a spike in the Yen. Once the necessary funds have been transferred and Yen repatriation has run its course the buying pressure on the Yen will subside. At that time traders will be wise to be watchful of a resultant fall in the Yen. Eventually, when things stabilize in Japan assets will move offshore again causing downward pressure on the Yen. Whenever traders seek a safe haven currency they must assess both the historic state of various currencies but the state today of the Yen, dollar, Euro, pound, or Swiss franc. Although the dollar has traditionally been considered a safe haven currency, its slow and steady fall reduces its attractiveness for holding long term. However, trading the dollar at times of Forex risk aversion can be profitable.

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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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Experienced Forex traders trade where the money is. In learning how to trade Forex, following the example of those with experience can be profitable. So, what are the most popular Forex trades today?

On the spot market, according to the 2010 Triennial Survey, the most heavily traded bilateral currency pairs were:

EUR-USD, 28%
USD-JPY, 14%
GBP-USD, 9%

The USD was used in 84.9% of trades compared to 39.1% for the Euro, 19% for the Yen, and 12.9% for the Pound Sterling. What are the most popular Forex trades today? See the following chart, which gives us a breakdown by currency involvement in all trades. The sum comes to 200% as there are two currencies in every trade.

What are the most popular Forex trades today and why? As the preceding table shows the US dollar, Euro, Yen, and Pound Sterling totals come to 175.2%. These are the major currency pairs. Forex traders trade these currencies because they trade in hold volume and high liquidity. They have lower buy to ask spreads than all of the remaining currencies so they trade with lower overhead. Technical trading algorithms work better with high liquidity and volume making technical analysis more effective with these currency pairs. As Forex technical strategies work better with these currency pairs these pairs are more attractive to technical traders.

Since the introduction of the Euro in 1999 it has risen steadily as a fraction of foreign currency trading. Part of these has to do with the steady erosion of the dollar and the slow but steady increasing use of the Euro, Yen, and Pound sterling instead of the dollar as the currency of international transactions. What is the Forex market today and what will it be tomorrow. So long as there is international trade there will be a need for Forex. As the long term dominance of the USD falls, traders will likely engage in more trades with the Euro, Yen, and Pound versus other currencies. For today, however, to trade non European currencies a trader typically has to trade a currency versus the dollar and then the dollar versus the second currency. Thus, the dollar remains a popular currency because it is the conduit through which other currency trades must pass.

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