Forex

Thursday, April 10, 2008

USD: Worst Quarter in 4 Years

In the first three months of 2008, the USD notched its worst quarterly performance since 2004, falling over 8%. During the same period, the Dollar lost 10% of its value against the Japanese Yen and 6.4% against a broad basket of currencies. Forex analysts reckon the slide was so steep because investors have taken stock of the US economic situation and have concluded that recession is inevitable. The story is also being driven by interest rates. The Fed has already cut rates by 300 bps in the current cycle of easing, making the benchmark federal funds rate the lowest in the industrialized world, in real terms. Meanwhile, the European Central Bank is giving every indication that it will maintain rates at current levels in order to keep a lid on inflation. As a result, the Dollar could fall further, especially if the Fed continues to hike rates and investors use the currency to fund carry trades. Reuters reports:

[According to one analyst], "And to call a bottom now is still a very risky call. It's too early to say the worst is behind us and the dollar's in for a sharp rebound."

Barclays Introduces Carry Trade ETN

Through its trademark iPATH line of funds, Barclays Bank recently introduced a new ETN designed to mimic the carry trade. In accordance with this strategy, this note is linked to the performance of the Barclays Intelligent Carry Index, which aims sell low-yielding currencies and use the proceeds to invest in those that offer higher yields. This index holds varying combinations of the so-called G10 currencies, which includes all of the majors as well as the Norwegian Krona and Swedish Krona. Traditionally, carry traders have sold one specific currency (i.e. Japanese Yen) in favor of another currency (i.e. the New Zealand Dollar). By instead purchasing this note, which will trade under the ticker ICI, investors can buy a share of an entire portfolio, optimized expressly for this strategy. Comtex reports:

The index is composed of ten cash-settled currency forward agreements, one for each index constituent currency, as well as a "Hedged USD Overnight Index" which is intended to reflect the performance of a risk-free U.S. dollar-denominated asset.

Forex Leads Equities

In recent months, the credit crunch has ignited a global trend towards risk aversion. As a result, a correlation has developed between equities, which serve as a proxy for risk, and certain currencies. The Forex Blog previously covered the link between the S&P 500 and the Japanese Yen, whereby the Japanese Yen moved inversely with the S&P as a decline in risk appetite led carry traders to unwind their positions. Perhaps, this connection can be seen in other currencies. Since the forex markets are open 24 hours a day and are the most liquid financial markets in the world, macroeconomic events are often priced into currencies before they are priced into equities. In addition, carry trading strategies have expanded beyond the Japanese Yen. In fact, the USD is now a decent candidate as interest rates are negative,when adjusted for inflation. Thus, an increase in risk appetite could simultaneously boost the S&P and punish the Dollar!

USD: Where is it Headed?

The last week has seen a spate of positive developments in the financial markets, including reassurances by several bulge bracket investment banks that their respective capital positions are in strong and in no need of shoring up. As a result, some analysts are speculating that the worst of the credit crunch has already been priced into securities and the USD, and that actual write-downs on subprime mortgage obligations won't match the "Himalaya-like guesstimates." At the same time, job losses are mounting and the unemployment rate recently crossed 5% for the first time in two years. Interest rate futures contracts suggest a 20% chance that the Fed will cut rates by 50 basis points at its meeting on April 30. Then, there is the ECB, which has been vocal about fighting inflation and European financial markets, which have benefited from "domestic" investors diversifying within the EU rather than to the US. Thus, there is no definitive answer regarding where the Dollar is headed in the near-term: everyone seems to have their own opinion. Bloomberg News reports:

The Dollar Index traded on ICE Futures in New York, which tracks the currency against those of six trading partners, dropped 0.2 percent to 72.049, its third straight decline. It was at a record low of 70.698 on March 17.

Central Bank of Japan Appoints Leader

For several months, the Central Bank of Japan had been leaderless, creating a situation that was politically and economically awkward. Finally, after much debate, Masaaki Shirakawa, a former academic and veteran central banker, was appointed. It is unclear what effect Mr. Shirakawa will have on Japan's economy, which is foundering (for reasons unrelated to the global credit crunch). He is considered highly competent, and analysts have suggested that he could help Japan develop a sensible and focused economic policy, which has been lacking for quite a while. With regard to monetary policy, he is unlikely to either raise or lower interest rates from the current level of .5%. Thus, if he is to return Japan to economic credibility, he will have to use other methods. Nonetheless, analysts are optimistic. The New York Times reports:

Simply having a hand at the central bank’s tiller will do much to restore global confidence in Japan and its ability to manage its $5 trillion economy, economists and former bank officials said.

Retail Appeal of Forex Grows

With average daily turnover of $3 Trillion, the foreign exchange markets are the largest financial markets in the world. Despite boasting such impressive volume and liquidity characteristics, forex is nonetheless considered extremely risky, and thus viewed as the bastion of experienced traders. This is slowly beginning to change, as investors have moved to diversify their portfolios away from the traditional allocation of stocks, bonds, and cash. Investing directly in forex still not recommended by financial advisers. However, there exist alternative strategies, such as buying CDs denominated in foreign currencies and/or securities that are issued by foreign companies and trade on domestic exchanges. These kinds of "indirect" strategies typically take the form of either "single play" or "double play" strategies. With both strategies, investors attempt to profit through cross-border interest rate disparities, but with "double play" trades, investors seek to profit from currency appreciation as well. The New York Times reports:

Mr. Orr advised currency buyers to research foreign nations and their credit risks, determine at the start their own risk-reward ratio and tolerance to volatility, and have exit strategies, while watching their positions constantly.

Thursday, April 3, 2008

Learn the benefits of Forex

The currency trading (FOREX) market is the biggest and fastest growing market on earth. Its daily turnover is more than 2.5 trillion dollars. The participants in this market are banks, organizations, investors and private individuals, just like you.

FOREX.com equips you with actionable trader education. Try free local seminars, dynamic online webinars, plus exclusive market commentary and trading ideas, straight from our traders. It involves trading one nation’s currency for the currency of another nation. As individuals or companies from one country trade across borders, the need for foreign currency arises.

Forex Education
Why we trade Forex?

There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit

This daily volume is larger than the combined volume of all the world’s stock markets. The FOREX market is not centrally located. It is an over-the-counter market where buyers and sellers conduct business linked by telephones, computers, fax machines, and other means of instant communications.

If you're brand new to the Forex market, start here.
Firstly understanding forex quotes Reading a foreign exchange quote may seem a bit confusing at first.
However, it's really quite simple if you remember two things: 1) The first currency listed first is the base currency and 2) the value of the base currency is always 1.
The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair.
For example, a quote of USD/JPY 110.01 means that one U.S. dollar is equal to 110.01 Japanese yen.

What is a pip? What does it mean?
The smallest price change that a given exchange rate can make. Since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point - for most pairs this is the equivalent of 1/100th of one percent, or one basis point. In the Forex market, prices are quoted in pips. Pip stands for "percentage in point" and is the fourth decimal point, which is 1/100th of 1%. In EUR/USD, a 3 pip spread is quoted as 1.2500/1.2503Among the major currencies, the only exception to that rule is the Japanese yen. In USD/JPY, the quotation is only taken out to two decimal points (i.e. to 1/100 th of yen, as opposed to 1/1000th with other major currencies). In USD/JPY, a 3 pip spread is quoted as 114.05/114.08.

What factors drive currency prices?
How Interest Rate Increases Drive Currency Prices
A common way to think about U.S. interest rates is how much it's going to cost to borrow money, whether for our mortgages or how much we'll earn on our bond and money market investments. Currency traders think bigger. Interest rate policy is actually a key driver of currency prices and typically a strategy for new currency traders. Fundamentally, if a country raises its interest rates, the currency of that country will strengthen because the higher interest rates attract more foreign investors. When foreign investors invest in U.S. treasuries, they must sell their own currency and buy U.S. Dollars in order to purchase the bonds. If you believe U.S. interest rates will continue to rise, you could express that view by going long U.S. Dollars. If you believe that the Fed has finished raising rates for the time being, you could capitalize on that view by buying a currency with a higher interest rate, or at least the prospect of relatively higher rates. For example, U.S. rates may be higher than those of Euroland now but the prospect of higher rates in Euroland, albeit still lower than the U.S., may drive investors to purchase Euros.

How Rising Gold Prices Affect Currencies
It's not hard to understand why we've experienced a run-up in gold prices lately. In the US, we're dealing with the threat of inflation and a lot of geo-political tension. Historically, gold is a country-neutral alternative to the U.S. dollar. So given the inverse relationship between gold and the U.S. Dollar, currency traders can take advantage of volatility in gold prices in innovative ways. For example, if gold breaks an important price level, one would expect gold to move higher in coming periods. With this in mind, forex traders would look to sell dollars and buy Euros, for example, as a proxy for higher gold prices. Moreover, higher gold prices frequently have a positive impact on the currencies of major gold producers. For example, Australia is the world's third largest exporter of gold, and Canada is the world's third largest producer of gold. Therefore, if you believe the price of gold will continue to rise you could establish long positions in Australian Dollar or the Canadian Dollar - or even position to be long those currencies against other major countries like the UK or Japan.

Translating Rising Oil Prices to Currency Trading Opportunities
Equity investors already know that higher oil prices negatively impact the stock prices of companies that are highly dependent on oil such as airlines, since more expensive oil means higher expenses and lower profits for those companies. In much the same way, a country's dependency on oil determines how its currency will be impacted by a change in oil prices. The US's massive foreign dependence on oil makes the US dollar more sensitive to oil prices than other countries. Therefore, any sharp increase in oil prices is typically dollar-negative. If you believe the price of oil will continue to increase for the near term, you could express that viewpoint in the currency markets by once again favoring commodity-based economies like Australia and Canada or selling other energy-dependent countries like Japan. Technical Analysis 101 The vast majority of forex traders rely on charts to forecast price action.

The basics of charting

Of the many market sayings thrown around by traders, perhaps none is more overused and less understood than the old adage 'the trend is your friend'. All too often, the phrase is used after a trader has taken a counter-trend position and subsequently been stopped out at a loss. Remorse sets in at this point and most traders themselves not only for having lost on a counter-trend trade, but also for not having caught the latest move in the trend itself. To avoid this all too common scenario, we will suggest using several technical tools to identify whether or not a trend is in place and then use additional indicators to help maximize trading profits. Having a strategy in place to identify trends is essential to successful trading in any market, but especially so in the case of the forex markets. Currencies have a greater tendency to move in trending fashion due to the longer-term macroeconomic elements that drive exchange rates, such as interest rate cycles or global trade imbalances.

Currencies are also pre-disposed to short-term, intra-day trends due to international capital flows reacting in unison to day-to-day economic and political news.Identifying the TrendIn its most basic sense, a trend is simply a prolonged market movement in one general direction, either up or down. From a traders' perspective, though, that simple definition is so broad as to be relatively meaningless. A more relevant definition of a trend would be one where a trend is defined as a predictable price response at levels of support/resistance that change over time. For example, in an uptrend the defining feature is that prices rebound when they near support levels, ultimately establishing new highs. In a downtrend, the opposite is true-price increases will reverse as they near resistance levels, and new lows will be reached. This definition reveals the first of the tools used to identify whether a trend is in place or not-trendline analysis to establish support and resistance levels.

Trendline analysis is often underestimated because it is perceived as overly subjective and retrospective in nature. While both criticisms have some truth, they overlook the reality that trendlines help focus attention on the underlying price pattern, filtering out the noise of the market. For this reason, trendline analysis should be the first step in determining the existence of a trend. If trendline analysis does not reveal a discernible trend, it's probably because there isn't one.

Trendline analysis is best employed starting with longer timeframes (daily or weekly charts) first and then carrying them forward into shorter timeframes (hourly or 4-hourly) where shorter-term levels of support and resistance can then be identified. This approach has the advantage of highlighting the most significant levels of support/resistance first and less important levels next. This helps reduce the chances of following a short-term trendline break while a major long-term level is lurking nearby.