Currency Trading

I have recently been looking into it, and might want to start as a hobby with some of my ‘risk capital’ which I can afford to lose in a worst case scenario. Any currency traders in the house? If so, how did you guys started initially? Please share your experience along with recommending some ‘must read’ books/material.

Yo Bchad, what’s your take on currency trading?

I find it a pretty bad way to speculate. The level of anaysis regarding currency strength against another is something I can’t even fathom. You’d need to be up to speed on on fiscal policy, monetary policy, and GDP implications for multiple countries.

Furthermore, there are enough quant shops out there doing triangular arbitrage to 100 decimal places to render the currency markets efficient.

In the CAIA, we learned that currency is no more than a store of value earning one close to the rate of inflation. It’s not a true ‘investment.’

Fundamentals matter in currency, but they can take a looong time to readjust, and lots of irrational or just unexpected stuff can happen in the interim. You are playing against major institutions like Central Banks who can just change their minds about policy and screw the fundamentals or at least change them significantly.

I agree that triangular arbitrage just isn’t feasible anymore if you’re not a HFT shop.

Technical analysis probably works better on currencies than fundamental analysis.

The currency markets allow people to obtain tremendous leverage, and that tends to promote very poor risk management. This is probably why most amateur currency traders blow up. Most movements are relatively small, so you lever up to make them more profitable, and then an adverse change at high leverage takes you out.

Currency earning close to the rate of inflation makes some sense assuming you are using money markets to store your currency, because the short rate resets quickly in response to inflation (obviously literal cash doesn’t earn interest and gets penalized for inflation). However, if there are differences in the real interest rate, you can do currency carry. You call it currency, but it’s actually more of an interest rate investment thesis.

The thing about currencies is that they are usually not volatile, but they are sensitive to event risk like central bank action. For instance, the daily change for JPY might be 0.1%, 0.2%, 0.15%, CENTRAL BANK SELLS USD - 2.5% change! So, margin traders might lever up in low volatility environments, then get a huge PnL from some event risk.

I actually manage a currency porfolio in my work - it’s not for prop trading, but you do get used to how the underliers move. Lately, I’ve noticed a lot of government intervention in exchange rates - so if you learn a bit about government policy, you might be able to predict some of the currency movements. For instance, buy BRL at 2.10 and sell at 2.03 because of the (unofficial) trading band.

The other thing I noticed is that currencies are very sensitive to risk environment and demand for commodities. For instance, AUD or NOK are correlated to commodity prices. So, if you have a view about China commodity demand, that can be expressed through a position in AUD. Other currencies like EUR have obviously been trading in response to economic policy risk. So, if you think there will be instability in the EZ, you might be able to trade EUR based on that.

Another thing you might want to try is the carry trade. For example, AUD forward prices are lower than spot, but JPY is in contango. So you can go long the AUD forward contract and short the JPY forward contract, hoping to earn carry. This is the sort of trade that makes money until some kind of event risk materializes. In general, governments don’t like exchange rate volatility, so carry trade is more reliable in currencies than in something else, like I don’t know - commodities or whatever.

Unfortunately, I don’t have any reading material to recommend. However, it would be a good idea to read finance news as much as possible and keep track of daily exchange rates. Once you find a couple of interesting currency pairs, you can do more research on those countries.

Ohai, when you say “unofficial trading band,” how do you know where that band is? Do you have a specific source that you used, or do you just pick it up from the chart that that’s where interventions seem to happen?

I often think of currency strength as representing how much the external world wants access to the things in the economy. Those things basically break down into 1) we want access to what they produce (pushes currency up), 2) we want access to their stocks/bonds/real-estate (pushes currency up), and 3) we want access to their consumers (pushes currency down). This is basically the balance of accounts model, but interpreted more meaningfully. It also explains why some currencies are more tied to certain sectors. High or rising inflation tends to be bad for currencies, but basically this is because it makes their financial assets less attractive.

It was a surprise to me to learn that the flows of currencies on a day to day basis are overwhelmingly flows for financial reasons, and not for trade reasons. It actualy makes some sense when you think about it, because currency decisions for investment are made on almost a minute by minute basis, where as for trade it tends to be much slower - say month-by-month.

Brazil never said where their band is - hence it’s “unofficial”. I’ve seen some research where analysts infer a band from Brazil central bank activity. The range I specified above is just eyeballed from the chart though.

I figured… I just wondered if there was something else I should know about in the future.

If you are just trading spot currency, then most of the major pairs adhere well to basic ‘technical analysis’. Then you just need to be aware of the macroeconomic indicators per country/region.

I think the danger in currency trading if you haven’t done it before, is to maximize your leverage, and then get chopped up.

Start with minimal leverage(even though you can get 200x), don’t be tempted to max your gains in the beginning.

Thanks Bchad, CvM, Ohai, Lockheed for your input. Bchad - what I have read so far has mostly been negative, some informal statistics state that 95% of the individual traders are losers, I can not confirm this figure but it sure is not much of a ‘welcoming’ vibe. I haven’t really invested much of my time to get into the depth of it and I would rather not do it altogether if its just a recipe for losing my capital and time which I can spend doing something more productive. CvM - I have a similar mindset when it comes to speculation, it sure can’t be called an ‘investment’, its more like a less than reasonable shot relying on technical analysis to a major extent, I personally don’t think its viable as an individual to keep a constant track of new developments and information to be able to base your reasoning fundamentally unless you are doing it as a full time job. Lockheed - Spot trading is what I was referring to. Agreed to the amount of leverage offered. It can blow you up pretty quickly if your risk management strategy doesn’t workout well. Ohai - Some good info. there, thanks. Have you tried short term spot trading individually?

If you’re using technical indicators, you may have something. As Ohai mentioned, you can rock paired trades, spots, futures, and so forth. If you have a solid model that can identify mispricings due to deviations from ‘bands’, have at it. I think Soros did something to the extent with a pegged currency that was unofficially mispriced.

I’m not going to pretend I’m smart enough to know all of the implications here. The CAIA touched on it and I wrote it off as another paper commodity that maintains a store of value, not so much a return on capital.

I do work with FX for work. But we typically use spots, forwards, and options to hedge the exchange risk. The goal is to turn a variable cost into a fixed cost when sweeping money across boarders and currencies.

297, I wasn’t trying to be so glum. All I’m really saying is that you may not want to *start* with currencies. If you don’t want to do stocks or stock indexes, then maybe you start with some commodities via ETFs. After some experience with ETFs, you might then try graduating to futures conracts if your portfolio size can handle it.

Currency trades are pretty much always a pairs trade (which means that you go long one currency and go short another), so a currency move can be because one currency got stronger or because another one got weaker. If your mind is into relative comparisons, it can be a good way to go, but it usually requires an analysis of both the base currency and the quote currency.

The main problem is what Ohai said. You get these tiny daily changes and you start to think “the moves are so small, but they let me use margin, so I’ll just lever up in order to make my decisions amount to something.” Then, suddenly, one of the Central Banks does something you didn’t expect, the currency moves 10x the normal range in the wrong direction, you were levered, and now you’re broke.

With stocks, you don’t get that kind of thing happening nearly as often, and you can often better diversify among stocks to dilute how events like that affect your portfolio.

If you don’t want to plow through earnings, PE ratios and the like with stocks, then commodities are mid-point.

Just some thoughts for you.

CvM - That’s the plan, but first I need to equip myself with understanding all the technical indicators more than I do now. Bchad - Agreed! I understand stocks better than I do currencies or even commodities. I am still relatively new to investments. I come from an accounting background. CFA level 1 has helped me learn a lot of new things. For now, I have got my hands on two books; 1. Currency Trading For Dummies; 2. Technical Analysis For Dummies. I hope to finish reading these two, practice on demos and then jump to doing it practically.

Martin Pring has a good book on technical analysis, and it’s one of the main texts in the CMT curriculum.

Also look for Van Tharp’s books. If you are trading, how you do risk management and position sizing is actually mo important than finding the perfect technical indicators.

Bchad - Thanks, appreciate it. I will look into both of your recommendations.

There are so many risks to currency trading, I don’t know where to begin. I have traded currencies on/off for about 4 years. In the end I stopped becuase I looked at my performance and saw clearly that I was a much better equity trader than a currency trader. The primary challenges are:

  1. High degrees of leverage needed to make any kind of meaningful money with the average size of most accounts. This of course leads to many retail investors blowing-up their accounts because of the high leverage. Unless you want to be earning $10 a trade or have $500,000 in play money you are likely going to be levered 10-50x. A 2% swing in the market uncovered can wipe your entire account at that level. Obviously you will have stop-losses but that is no panacea. The tighter the stop-loss the more quickly you can get whiplashed out of a trade in a death-by-a-thousand-cuts way. The wider the stop-losses the more devestating big losses you take. No easy solution here. Its not like stocks where you can sit on a stock you have faith in and wait for the market to turn-around. With even 5x leverage you don’t have that comfort as you will get margin called at some point.

Currencies tend to trade in trends a lot more than equities, and if the trend moves away form you, regardless of the fundamentals, it will eventually wipe you out. Months later it will move where you thought it should move all along but of course that is cold comfort.

  1. Tremendous amount of information to follow. There is fiscal policy, central bank positions, macroeconomic conditions, balance of trade, inflation, etc. Now multiple that times 2 since every currency is traded as a pair against another currency. The complexity of trying to determine how the tremdenous volume of daily and weekly information that is released relating to each of the two countries in a currency pair influences price action in the pair is mind-boggling.

  2. Currency pairs lend themselves well to technical analysis but finding the right time-frame and indicatrs is challenging and they “right” ones change. Strategies that worked well in one environment (i.e. range-trading) don’t work well in up-trends or down-trends or during intense volatility or during extremely low volatility or during news-driven environments (i.e. politically driven markets, etc.). You need to have winning strategies, indicators and techniques for the many different market environments you will face. In my experience they change much more quickly than the equity markets.

  3. Don’t understestimate the ability of Draghi, Bernanke or Shiakawa to absolutely wreck your open position with a sneeze. Literally that’s all it takes. You can get stopped out with a sizeable loss in seconds because Draghi made some comment about bank loans while playing golf that was overhead by some reporter. Sometimes big banks and funds plant fake stories/rumors/whispers that have equal affects and later turn out to be unfounded.

  4. Need enough capital to start with to make it worth your time but if you do its likely more than simply your fun “risk” stash of cash.

In the end, I realized about a 20% loss over a 4 year period on the 8% slug of my portifolio that I had dedicated to currency trading and consider myself lucky. I learned a lot about technical analysis in the process and day-trading and emotions and consider it a great education that has definitely helped me and influences my equity strategies to this day. Bottom line is I just make a lot more money trading equities and have a real feel for the market which I simply was not able to develop int he currency world. And I am someone that *loves* following global macroeconomic and politica-economic trends (part of the reason it attracted me in the first place) purely out of personal interest.

My advice would be to avoid. Most retail currency traders lose 100% of their account within the 1st year. That statistic was published somewhere by one of the big brokers but I can’t remember where. But if you really want to try, its easy to open up a trial account for fee with no money down. You can try your hand at it and it costs you nothing. Of course you’ll never get good at trading with fake money but its a good place to start.

***I highly recommend Boris Schlossberg and Kathy Lien’s research services. Kathy has a couple of excellent books on currency trading that are worth purchasing and they both publish free-daily analysis of market-moving currency trends from both fundamental and technical points of view. I still read these because they are informative for the equity markets as well adn these guys are the best in the business. They are on Bloombgerg, CNBC, etc. literally on a weekly basis…

Skip these two books and get the following:

  1. Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market and

  2. Little Book of Currency Trading

Both are by Kathy Lien. The first really is the bible for retail currency trading in my opinion. The second is a bit redundant but newer and has some newer strategies. Its a short read. Boris Schlossberg’s book on technical analysis, Technical Analysis of the Currency Market, is also good but dense. If I had to pick only one book it would be the first book I listed. It covers technical and fundamental analysis for currency pairs, basic approach on how to make a go of currency trading on a day to day basis, and good strategies for trading news events.

I thought I remembered Soros saying in an interview that Forex was the only market he couldn’t consistently do well in. Maybe I’m mis-remembering.

Ironically, his legendary status comes from a forex trade. He did break the bank of England.

Mad Respect.