The Forex Nitty Gritty

Could there be a run on French banks if credit agencies downgrade their debt ratings? A bank run is when many customers of a bank simultaneously wish to withdraw funds. They do this, commonly, because they believe that the bank might go into bankruptcy and that they, the customer, will lose money. If a sufficiently large number of customers decide to withdraw their money for fear of the bank becoming insolvent it can become a self-fulfilling prophecy. A possible run on French banks is of concern because the large deposits that many nations, including Germany and the US have in these banks. It was the run on many US banks in the early 1930’s that helps create the Great Depression. The prospect of a Greek debt default is especially worrisome for French banks as they hold substantial amounts of Greek debt. As with other bank runs it is the prospect of losing money that drives depositors to withdraw funds.

There are a number of ways that banks attempt to prevent a run. An old and often successful procedure is to close the bank temporarily. Such a “bank holiday” stems the flow of capital out of the bank while other measures are instituted to protect the bank. Deposit insurance helps protect depositors but the amounts of deposit insurance are useful for individuals and not for nations. The interconnectedness of banks and other financial institutions is such that damage from a run on French banks and subsequent collapse could spread to North America and Asia. It is a measure of how seriously investors take this situation that when news of a possible resolution to the European debt dilemma emerged this last week socks soared in the US and worldwide. Varying foreign currency rates have been a hallmark of this situation.

Nations throughout the world have been trying to get a hand on the degree to which their banks are exposed to this situation. The US Federal Reserve announced that it is analyzing the books of the six largest US financial institutions for European, especially French, debt. It is pertinent that Bank of America, Citigroup, Goldman Sachs, Morgan Stanley, JPMorgan Chase, and Wells Fargo have deposits equal to two thirds of the US GDP which comes to a little under $10 Trillion USD. The concern of the Fed is the currency swaps in which these folks have engaged. In a currency swap two parties exchange currencies or interest payments on currencies on a fixed future date. These are Forex transactions. Speculators use these in search of profits. Central banks may use these to keep currencies stable. The concern of the Fed is that US banks may have excessive exposure to the Euro and the risk of a Euro collapse if the European debt dilemma becomes unsolvable. This combination of Forex and sovereign debt has plagued the markets for over a year and may, indeed, produce a run on French banks. As credit agencies such as Moody’s appraise the situation Forex traders are wary of movement of the Euro and the US Federal Reserve is pumping dollars into Europe in order to forestall a global financial disaster.

More Resources

An interesting new problem may have arisen for currency traders, how to trade a declining Yuan. The assertion regarding the Chinese currency for many years has been that the People’s Bank of China buys dollars in order to reduce the value of the Yuan and keep Chinese exports flowing. The continuing balance of payments deficits that the US, especially, runs with China, has led US and other lawmakers to demand that China allow its currency to float without any intervention. The theory is that by allowing the Yuan to float Chinese exports will become more expensive and less competitive. Now it appears that the Yuan is falling in value, and not because of currency manipulation. Today’s currency traders trade a declining Yuan as the global economic recovery weakens and the twin financial crises in North America and Europe threaten a second dip to the recession and substantially reduced imports from China. In addition an increase in Chinese imports may well erase the Chinese trade surplus, according to Chinese sources.

Those who currently trade a declining Yuan, have watched as Yuan forwards declined. Forwards are derivative contracts used to hedge currency risk or engage in currency speculation for profit. Unlike trading options on currencies no money changes hands when a forward contract is agreed upon. Also, unlike options contracts, both the seller and the buyer are obligated to fulfill their portion of the forward contract on the delivery date. As currency traders anticipate a falling Yuan, forwards decline. The early result of the debt crisis in Europe and the USA has been the appreciation of other currencies, including the Yuan. However, the threat of a substantial economic downturn in both economies threatens Chinese exports and threatens to drive down the Yuan. Chinese exports did, in fact, fall last month. While talk of internationalization of the Yuan persists its value seems to be driving today by the market and much less so by currency manipulation.

To trade a declining Yuan will require a change of mindset for many traders. The Yuan rose to a seventeen year high against the dollar in mid-November, after a nearly four percent run up this year. Some may merely view this as a correction. However, the debt issues in Europe and North America are terribly real. Thus the Asian exporters who have profited from keeping their currencies weak and have built up huge dollar and Euro currency reserves are likely to pay a price in terms of reduced exports. A silver lining to the clouds may be that as the Yuan depreciates the value of China’s reserves will go up. For those set to trade a declining Yuan two general issues come to mind. One is that the continued appreciation of the Yuan is not guaranteed, especially if China ceases to manipulate its currency. The other is that China has its own set of internal issues and problems. The nation has had steady economic growth for years and many Chinese would consider it political suicide to drastically reduce exports and cash flow into the country. China states that it intends to increase development of internal infrastructure projects in order to maintain high employment and its internal economy. With time, to trade a declining Yuan or a rising Yuan traders may spend less time concerning themselves with currency manipulation and will watch the same sorts of employment numbers and statistics as they watch in the USA when trading the US dollar. With time the Yuan could join the dollar as a safe haven currency.

More Resources

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.

More Resources

Currency and stock traders have been hoping to see tangible signs of a global economic recovery. When the largest heavy equipment manufacturer in the world, Caterpillar, reported better than expected earnings it also predicted growth in the three percent range through the end of 2012. Stock markets reacted positively and currency traders are looking to see which currencies will profit the most. A lot of the construction spending coming this next year has to do with the ongoing reconstruction efforts in Japan following the worst earthquake and tsunami in the history of the island nation. Construction in Japan as well as in the USA are expected to help lead global economic recovery this next year. Does that mean that the YEN and USD will rise as well? Investing in the US dollar was a good bet recently as the dollar rose against most currencies and falling interest rates on T bills made assets held in dollars and T bills doubly valuable.

Traders recognize, however, that the Japan and Switzerland have been selling their currencies recently to avoid high priced Yen and francs. Traders also recognize that for a global economic recovery to really gain steam the European Union needs to follow through with promises and its more prosperous members need to ante up somewhere in the neighborhood of €2 Trillion in order to resolve the continuing debt dilemma. If this happens most traders expect to see a rally of the Euro which could lead to a falling dollar. Although many see the dollar as a safe haven currency a rising Euro could compete as a secure currency to park assets in time of economic distress. Likewise, if the Swiss and Japanese stop dumping their currencies they could rise as well. Smart traders are using options to hedge currency risk.

A positive factor pointing to a continued global economic recovery, as opposed to a second dip of the worst recession in three quarters of a century, is the fact that many US companies are flush with cash. Many, in fact, have substantial sums offshore. If legislation meant to encourage a repatriation of these assets goes through it could bring a lot of dollars back to the USD and also drive the dollar higher. This would be a situation similar to the Yen repatriation scenario earlier this year when Japanese investors divested themselves of investments denominated in dollars and other currencies and converted these currencies back into Yen. These investors had been engaged in the so called Yen carry trade. They were able to move assets out of Japan with its low interest rates and convert to currencies where interest rates were higher. When the earthquake and tsunami wreaked havoc on the nation many needed assets back home in Japan to finance reconstruction efforts. The resulting wave of purchases of YEN drove the currency up very rapidly and only a threat of unified intervention by the combined financial ministers of the G7 served to stabilize exchange rates. As a continuing global economic recovery seems more likely there will very likely be substantial cash flows for investment and well as asset repatriation. Currency traders are well advised to follow fundamentals and technical aspects of their currency pair of choice in the coming months.

More Resources

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.

More Resources

Forex traders trading the AUD do well to keep their eye on the commodities markets, specifically coal, iron ore, copper, gold, natural gas, wheat, cattle and uranium. Australia is a large island nation (sixth largest in the world) with a relatively small population (22 million being number 55 in the world. It is blessed with abundant natural resources and proximity to the growing industrial powers of Asia. Thus Australia only suffered one quarter of negative growth during the current worldwide recession and has seen its currency, the Australian dollar – AUD – go up from 1.3285 to the USD in 2006 to 1.0902 to the USD in 2010 (CIA Factbook). How to trade currency such as the AUD always has to do with understanding the fundamentals that drive currency rates. Trading the AUD also has to do with reading market sentiment as the actions of many traders and businesses hedging currency risk come together to create a market price. The proximity of China, Japan, and Korea, especially, to Australia and its natural resources provides the Australian economy with advantages that can result in the ascent of the AUD. This ascent may not be only versus the USD, EURO, and YEN but against the Chinese Yuan. The perception of continued growth lends itself to profits for those who understand day by day market sentiment in trading the AUD.

Trading the AUD can be similar to trading the Real – BRL, Rupee – INR, Yuan – CNY, or Ruble – RUB. Brazil, India, China, and Russia all have growing economies. These nations also have economies that are substantially smaller than that of the USA or the EU. This situation gives these nations substantial room to grow and prosper. It trading the AUD it is not important that there are a lot more US dollars or Euros than Australian dollars in the world. The only important factor for those trading the AUD is the relative value of a currently falling EURO versus a rising Australian dollar or the strengthening of the USD dollar against the Australian dollar. Although the AUD is commonly quoted against the USD it can be traded against any major currency, including the Yen, Euro, Swiss franc – CHF, British Pound – GBP, or Canadian Dollar – CAD. Trading the AUD against another generally rising currency such as the Real, Rupee, or Yuan will typically not be as profitable as trading the AUD against a currency that is in trouble, such as is the case with the EURO today. A Forex trader considering how to short the EUR may, at times, do better shorting the Euro against the AUD than against the USD.

A long term consideration in trading the AUD is that Australia is a net exporter of both raw commodities such as coal and wheat as well as an exporter of finished steel products and processed meats. As Asia leads the world out of the recession Australia is ideally situated to do business with and China, Japan, and Korea as well as other prosperous Asian nations like Singapore and Taiwan or the most populous Islamic nation in the world, Indonesia. As always we are not suggesting that traders buy or sell AUD but offer an example of thinking through the fundamentals of a major world currency. Trading the AUD can be profitable but a successful Forex trading system requires thoughtful preparation, discipline, and timing.

More Resources

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.

More Resources

The world awaits a meeting of the US Federal Reserve Foreign as foreign currency rates are likely to respond directly to the actions of the Fed. After the credit rating agency, Standard and Poor’s, downgraded US debt two things happened. Stock markets around the world fell and US treasury notes were in such high demand at auction that the ten year bond went for 2.3% percent, the lowest in three years. Although there is general consensus that both the US and Europe need to get a handle on their debt there is also an underlying concern that a policy of absolute fiscal austerity would plunge the USA, and the world, back into recession. Forex traders and investors are therefore very interested in whether or not the Fed drops interest rates in order to support the US economy or leaves them in place. Foreign currency rates will likely respond the any Fed announcement although the direction of foreign currency rates is not all that certain. The surprising interest in US treasuries tells us that the US dollar is still seen as safe haven currency and that US treasuries are still considered a safe bet. According to press reports Fed chairman Bernanke has been preping the market for likely Fed moves. After an urgent conference call with G7 financial ministers the GA7 issued a statement saying they would take “all necessary measures to support financial stability and growth”. But what will happen to foreign currency rates is there is an Italian debt default?

The situation in Europe is probably bleaker than in the USA. Thus foreign currency rates that include the Euro will likely favor the other currency unless the EU can staunch the flow red ink in Italy, which is the newest nation on the continent to threaten sovereign debt default. The Greek debt crisis, in fact the  PIIGS crisis (Portugal, Italy, Ireland, Greece, and Spain) has been brewing for over a year and has been a drag on the Euro. There is concern that if one of these nations defaults on its debt it could become contagious and there would be a round debt defaults across the globe. Foreign currency rates would become chaotic and, in all likelihood, favor the traditional safe haven currencies, namely the Swiss franc, the Yen, and, yes, the US dollar.

Watching short term foreign currency rates and trading with technical analysis as a guide can be profitable in foreign exchange trading and moves in foreign currency rates. For the long term traders need to look at the fundamentals and attempt to divine the intent of central banks, the US Federal Reserve, and national leaders as the debt crisis continues to simmer and threatens to boil over. A useful insight for traders is that while the S&P debt downgrade affected stock markets throughout the world it had an opposite effect on US treasuries and the US dollar. As civil war continues in Libya and threatens in Syria pro-democracy movements continue throughout the Middle East the world is a potentially unstable place and this will be reflected in foreign currency rates.

More Resources

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.

More Resources

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.

More Resources