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 event. 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- ments. “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.” W 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
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