Investing & Trading

It has been three years since the Bank of International Settlements’ last report on foreign exchange was released. Since then, analysts could only speculate about how the forex market has evolved and changed.

The wait is now over, thanks to a huge data release by the world’s Central Bank, which showed that daily trading volume currently averages $4.1 Trillion, a 28% jump since 2007. Trading in London accounted for 44% of the total, with the US – in a distant second – claiming nearly 19%. Japan and Australia accounted for 7% and 5%, respectively, with an assortment of other financial centers splitting the remainder.

With the onset of the Eurozone sovereign debt crisis this year, volatility levels in forex (as well as in other financial markets), surged to levels not seen since the height of the credit crisis. While volatility has subsided slightly over the last few months, it still remains above its average for the year, and significantly above levels of the last five years.

With today’s post, I want to take off my currency trader hat and put on my investor hat.

You might be tempted to argue: But wait, these two aren’t mutually exclusive. Isn’t it possible to wear both hats? While it’s theoretically plausible for a trader to take a long-term view of the markets based on fundamental analysis, I don’t think it’s likely in practice. In the end, a good investor will always have a longer time horizon than a good currency trader. In short, someone who bought shares in Apple 20 years ago is now probably a millionaire. Someone who went long the USD 20 years ago has probably since lost his investment due to inflation.

The risks in trading forex are manifold. There is interest rate risk (the possibility that interest rates could change adversely), country risk (that a political, economic, or monetary crisis could adversely affect the dynamics of a country’s currency), and obviously there is exchange rate risk (that exchange rates can and often do fluctuate adversely). However, there is zero or nil credit risk. Why is that?!

I have always wanted to write a post about seasonality, but whenever push came to shove, I couldn’t see the point. Besides, I was never sure whether seasonality falls into the scope of technical analysis or whether it made sense to consider in fundamental terms, and for fear of overstretching, I stayed away. Recently, I read a column by Kathy Lien about forex seasonality. In fact, this article was merely an updated version of a nearly identical article that she contributed earlier to Investopedia, but nonetheless I found it informative, and I was finally inspired to address the topic on the Forex Blog.

Upon reviewing my previous post on the Brazilian Real (BRL), I now realize that it lacked context. In other words, while both the interest rate outlook and economic prospects of Brazil are both incredibly bright, who’s to say that this hasn’t already been priced into the Real? At the very least, more information is needed to determine whether the Real is valued fairly on an historical and/or relative basis. [Alas, the focus of this post isn't on the Real specifically, but on the forex markets in general. Still, the concepts that will form the backbone of this post - volatility, risk, and carry - can be seen clearly through the prism of the Real.]

The Wall Street Journal’s coverage of the Greek dent crisis has focused less on the crisis itself, and more on the markets’ reaction to it. With headlines like “Hedge Funds Try ‘Career Trade’ Against Euro” and “Speculators Bet Record Amount Against Euro For 4th Week” and “Europe Trouble, U.S.

Kudos to anyone who correctly identifies that reference. But seriously, in light of the proposed changes in forex regulation that have generated a heated response on this blog and elsewhere, I want to offer some insight into a tangential issue: jurisdiction.

Part of the problem with existing forex regulation is not that it’s insufficiently strict, but rather that it’s essentially optional. That’s because retail forex brokerages do not technically need to be registered in order to operate. Moreover, if they do register, they can choose between several organizations, depending on whose regulations most jive with their business models.

I try not to editorialize much when writing this blog. There are too many talking heads as it is, which is why I try not to interject own opinions into the facts. Admittedly, the notion of facts in forex is obviously a bit murky, but I stand by my approach, nonetheless. Today, I would like your permission to stray from the facts (well, not entirely) and offer my opinion on the recently proposed regulatory overhaul for trading forex.

After the impressive rally in the US Dollar at the end of 2009, many market observers predicted that the end was near for the Dollar carry trade. That’s because volatility is the sworn enemy of carry traders; whenever there transpires a sudden change in direction in a funding currency, investors will usually race for the exits, regardless of whether the change was justified by fundamentals.