Learning Center
Plans & pricing Sign in
Sign Out

key tactics in forex trading Aug08


									6                                                                                               VOLATILE MARKETS                                                                             26 AUGUST 2008

Make money from money with the
three key tactics in Forex trading
Understand the basic                                                                                                                                                   Valuation trading comes down to a fun-
                                                                                                                                                                    damental view of whether a currency is
trades and you can                                                                                                                                                  over- or under-valued. Soros spotted that
                                                                                                                                                                    with sterling in the early 1990s but other
profit from foreign                                                                                                                                                 examples tend to be less obvious than that
exchange, writes Phil                                                                                                                                                  The most popular way to identify that is
                                                                                                                                                                    through purchasing power parity (PPP), a
                                                                                                                                                                    theory based on relationship between rel-
Thornton                                                                                                                                                            ative inflation performance of countries
                                                                                                                                                                    and longer-term exchange rate move-
                                                                                                                                                                       “Inflation under PPP theory has a long-
 FX Trading                                                                                                                                                         term effect on a currency,” says Ryan
                                                                                                                                                                    O’Doherty, trading education specialist at
                                                                                                                                                                    CMC Markets. “Low inflation is seen as a
                                                                                                                                                                    sign of a healthy economy that is likely to
                                                                                                                                                                    attract foreign investment, thus creating
                                                                                                                                                                    an upward pressure on the country’s
                                                                                                                                                                    exchange rate.”

           ITH equity, property and bond                                                                                                                               When it comes to following a momen-
           markets going through a rough                                                                                                                            tum strategy, such as a strong dollar or
           time, investors are increasingly                                                                                                                         weaker pound, traders need both a funda-
           tempted to see currency trading                                                                                                                          mental view and the ability to read techni-
as a safe haven.                                                                                                                                                    cal analysis.
  However newcomers should remember
that while the gains can be impressive,                                                                                                                             REGIONAL ECONOMY
those without a clear strategy can suffer                                                                                                                           “You need to look at and understand the
losses that would make share traders                                                                                                                                deep relationship between a currency and
blanch.                                                                                                                                                             its regional economy,” says Tony
  The most famous example is the £3.3bn                                                                                                                             Celentano, head of sales at E*TRADE
the Bank of England lost in 1992 betting                                                                                                                            Securities.
against billionaire speculator George                                                                                                                                  Traders need to know how to interpret
Soros’s position that the pound’s fixed                                                                                                                             macroeconomic data on GDP, inflation,
exchange rate against the German bund                                                                                                                               monetary policy and international trade
was unsustainably high.                                                                                                                                             and capital flows.
  There are a whole host of factors that                                                                                                                               While that will help a trader to take a
can push exchange rates around.                                                                                                                                     fundamental view, technical analysis
Economic data, central bank decisions                                                                                                                               enables them to decide when to enter and
and political events can affect analysts'                                                                                                                           exit that trade and how large a position to
view of a currency.                                                                                                                                                 take.
                                                                                                                                                                       “You can have a fundamental view
TECHNICAL FACTORS                                                                                                                                                   about a currency but if the technical chart
At the same time technical factors such as                                                                                                                          is showing that it is overbought that
market interest rates, shifts in foreign                                                                                                                            would make you not buy it until you get a
investment and cross-border takeovers,                                                                                                                              clear signal,” he says.
commodity prices and international trade                                                                                                                               O’Doherty at CMC Markets agrees.
can influence how currencies trade                                                                                                                                  “Fundamental analysis is concerned with
against each other.                                                                                                                                                 the study of the influences of supply and
   Increasingly, currency traders look for                                                                                                                          demand on price, technical analysis is con-
clear and transparent strategies to ensure                                                                                                                          cerned only with price and direct meas-
they are not buffeted by one-off events.                                                                                                                            ures of price action,” he says.
   Traders and analysts focus on three                                                                                                                                 He says the advantage of technical
well-defined trading strategies – carry,                                                                                                                            analysis in the foreign exchange markets
momentum or trend following, and valua-                                                                                                                             is its applicability to all floating and trad-
tion.                                                                                                                                                               ed currencies and of use in almost any
   The carry trade has hit the headlines in                                                                                                                         timeframe.
recent months – and for good reason. At                                                                                                                                All major online platforms provide
the heart of the strategy is borrowing in a                                                                                                                         research and charting facilities that are
low interest rate currency and investing in                                                                                                                         designed to allow traders to carry out
a higher interest rate currency.                                                                                                                                    their own analysis.
   The most famous example was investors                                                                                                                               Waters at dbFX says: “Forex trading is
borrowing in Japanese yen while Tokyo                                                                                                                               very technical so people who trade in
kept interest rates close to zero and invest-                                                                                                                       other markets by staring at charts and
ing in New Zealand, where the official                                                                                                                              comparing company A with company B
interest rate has risen from 7.25 per cent                                                                                                                          will enjoy forex.
to 8.25 per cent since January last year.
   The momentum strategy follows clearly                                                                                                                            FAST-MOVING MARKET
identifiable movements in currencies,                                                                                                                               “But at the same time if you have a funda-
such as the long-term decline in the value                                                                                                                          mental opinion you can do very well.”
of the dollar since 2002.                                                                                                                                             One danger for new investors is getting
   Lastly, valuation seeks to identify cur-                                                                                                                         caught up in the excitement of a fast-mov-
rencies that are overvalued and those that                                                                                                                          ing market. “The foreign exchange market
are undervalued. Since currency trading                                                                                                                             consists of many participants who often
works by buying one currency and selling                                                                                                                            over-react to situations and facts,” says
another, the way to execute this strategy is                                                                                                                        O’Doherty.
to take short positions in overvalued cur-                                                                                                                            “A trend that is not necessarily justified
rencies and using the proceeds for long            What all these three have in common is        Everybody’s getting   currency they have bought as well as any     rationally can still move in an irrational
positions in undervalued currencies.            that they are long-term strategies based         into the money        currency move.                               direction over the short term.”
                                                on a cool and calm assessment based on           markets.                “People have done very well with carry       Waters at dbFX advises new traders stick
POSITIVE RETURNS                                in-depth research.                                                     trade recently,” says Waters. “It depends    to a long-term plan rather than trying to
Each of the strategies is easily implement-        The carry trade has been the most prof-                             what you are looking for. If you are look-   make a quick profit. “Good currency
ed, in part because they are so well known      itable in recent months as traders benefit                             ing for an interest rate play then carry     traders make money in the long term by
and straightforward, but also because exe-      from the large interest rate differentials as                          makes sense.”                                being disciplined, not necessarily by mak-
cution costs in currency markets are so         well as the movement in the exchange                                                                                ing short-term bets.”
small.                                          rate.                                                                                                                 Celentano at E*TRADE Securities urges
   A study of the performance of 113 pro-          Betsy Waters, who is global director at       The carry trade has been the most profitable                       small investors to start out with small
fessional currency managers between             dbFX, Deutsche Bank’s online currency                                                                               positions. “There’s no point opening big
1990 and 2006 by Richard Levich, profes-        platform, says that the carry trade is some-     in recent months, as traders benefit from the                      positions,” he says. “Dip your toe in the
sor of finance at New York University,          thing of a double whammy. It has the                                                                                water - don't jump in.”
found that two-thirds of their positive         advantage that traders receive the benefit       large interest rate differentials                                    Phil Thornton is lead consultant at research
returns came from these strategies.             of the interest rate on the high-yielding                                                                           house Clarity Economics

To top