Long-term Forex Perspectives

Long Term Forex Perspectives Blog stops updating

 We have to say good-bye to the blog of our dear friends John Jagerson and S. Wade Hansen. Due to agenda reasons they won’t be able to keep on posting their excellent comments. However, they will continue contributing with FXstreet.com by publishing their weekly reports: Video Analysis for the Majors, Video Analysis for Small Dollars, Video Analysis for JPY crosses and of course holding their education webinars. Shortly they also will be submitting us some contents for the Education section.
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Want to make a bigger premium on your forex positions?

As many of you know, I am a big advocate for the advantages of using options in the forex. They are a great way to speculate, manage risk and hedge against losses in your forex portfolio. The same strategies used by options traders in the stock market can be applied to a forex position with a few minor modifications. One of the most popular options strategies out there in the stock market is the covered call. This idea can be used in the forex with similar benefits.

The idea behind a covered call is to enter a long position in a security or forex pair, I will use the AUD/USD in this example, and then to sell a call option against that position. You get paid the premium for that call option and can keep all of it if it expires out of the money. It simultaneously pays you a nice premium and hedges downside risk. It is considered "covered" because the losses you would normal incur on a naked call when the market runs up are offset by the gains in the underlying. The trade off is that you have given up some profit potential if the pair moves big to the upside. This is a great strategy when you are not sure the market is going to move very far or want to hedge a little risk to the downside.

In my example, I would apply this strategy to the AUD/USD which is priced at 1.0545 as I write this article. I can sell a call with a strike price of .9100 for $95 per contract or basically the equivalent of 95 pips per $10,000 lot. If the market rises within 30 days before option expiration, I will get "called out" and get to keep my $95 of profit plus some of the upside from the pair's movement. If the market falls, the call will also fall in value and ultimately I could let it expire in 30-days worthless. If that happens, I will keep the $95 per mini-lot, which can offset some of the losses I have accumulated. I am now free to repeat the process over again for the next month.

This can be a great way to take advantage of a currency pair that is channeling in a tight range and that I think will likely continue to do so over the short term. Before entering a position like this you should probably have a fairly neutral outlook on the pair and be ready to close the position if the market begins to run down very quickly.

For more information on FX options strategies, see our course here:


 

The other North American currency

Interestingly, I find that very few traders follow the MXN or Mexican peso. This is the third of the three big North American currencies and has its own advantages and personality. One of the best things about it is that it is plenty volatile. In the chart below you can see the the channel that has been in play for the last year, which still appears to be intact and may be a nice opportunity to diversify.

The MXN, like all currencies, is influenced by a variety of factors. Since the currency crisis in '94 the MXN has been very sensitive to credit market and interest rate issues. Lately that has led to the MXN strengthening when US credit gets tight. That can help hedge against some risk in the US.

The MXN is also very sensitive to oil prices, often weakening significantly on merely stagnant oil prices. In fact, "commodity currency" traders may look to the MXN as a better alternative to the CAD for trading oil prices or hedging against them. Currently, the USD/MXN is at the bottom of its long term channel and with oil prices looking weak, the potential rally could be significant. The bottom line is to make sure you are aware of opportunities outside the majors. There is more than just the EUR/USD in the market.

For more commentary and education, come see us at www.pfxglobal.com

Weekly chart of USD/MXN

Profiting from fear

by John Jagerson

It is tough to limit yourself to a single market and often as a forex investor it helps to be able to use the other financial markets to offset and diversify risk. We are all aware of the tendency for several forex pairs to follow stocks and stock investor sentiment. There is a way to benefit from these shifts that may help diversify a forex portfolio.

I think that forex traders ought to check out the VIX as an investment opportunity. I thought it would be helpful to post a few tips and an important warning in this article. In case you don't already know, the VIX is a measure of the S&P 500 index-options' volatility. Traders call it a measure of fear because that is really what it does. When fear rises, the VIX rises because volatility is going up. when investor confidence is rising the VIX will fall and stay low.

There are options available on the VIX. If you think fear will rise and therefore the VIX will climb, you can buy a call. If you think fear is going to fall you can buy a put. If it turns out that you were right, you will have made a nice profit. That profit may offset losses from sudden reversals triggered in the forex market. The great thing about the VIX is that it can be a nice way to diversify your forex portfolio. We all know that rising fear and volatility can wreak havoc on your equity curve and having a hedge in there on the VIX is a great way to offset some of that risk. You can find the VIX options on most online options-brokerage applications under the symbol VIX. You can pull the index up on Yahoo! finance with the symbol ^VIX or on Prophet.net with the symbol $VIX. Both of those charts are free.

Here are a few tips for using the VIX.

Tip #1 - When volatility is low (less than 15) it tends to stay low and is a great opportunity for market neutral strategies using short strangles or credit spreads.

Tip #2 - When volatility is high (above 20) it tends to stay high and will channel. That is a nice environment for trading support and resistance bounces.

Tip #3 - These are exchange traded options so any options broker can accommodate your trades. If you call your broker and they don't know what you are talking about you may want to shop for an options specialist.

Tip #4 - If you are not sure what these options strategies mean, I have some video tutorials on my site that you can check out for free on options trading.

Warning! - If you are an options spread trader but have never traded options on the VIX before you will immediately notice that diagonal spreads on the VIX look risk-free. They are not. The issue is that each month's contracts are based on a different futures contract so it can throw you off.

Daily chart of the VIX

Dead-Dollar Bounce?

Traders see "dead-cat bounces" all the time. My question is, are we seeing a "dead-dollar bounce"?

If you're unacquainted with the term "dead-cat bounce," Wikipedia gives the following definition:

A dead cat bounce is a term used by traders in the finance industry to describe a pattern wherein a moderate rise in the price of a stock follows a spectacular fall, with the connotation that the rise does not indicate improving circumstances. It is derived from the notion that "even a dead cat will bounce if it falls from a great height".

We are seeing the USD bounce off of all-time lows today (7 March 2008) against the EUR on news of lower unemployment rates in the U.S. (down from 5% to 4.8%), but there is still plenty of bad economic news that will most likely keep the USD down in the near term.

Even though unemployment fell today, the U.S. reported a loss of 63K jobs. Coupled with rising oil prices, the Fed looking at lowering interest rates in the face of impending inflation and a continuing housing crisis, today's overall employment outlook doesn't look good.

It appears that investors may be taking some profits off of the table as we head into the weekend, but don't look for the USD to regain much strength during the next few weeks.

If you're long the EUR/USD, keep your stop orders current, but the longer-term trend should continue to push the EUR/USD higher.

New products = new opportunities

I know that forex options are not really a new product but they are being made available in new ways to a broader audience than ever. I am always interested in what the CME is doing and they have been pushing new spot equivalent futures as well as 24 hour availability of forex options. Why is this useful? I think retail traders had one hand tied behind their back for years. If they wanted to control risk in a position they could choose a stop loss or.... a stop loss. Options present a whole new way to control risk and "leverage" trading opportunities.

Let me provide an example....

Imagine you are long the EUR/JPY in the long term and feel like it has hit a bottom so you want to scale into a larger position. That is risky considering recent volatility and the exposure to whipsaws from tight stops may put this trade out of consideration. However, buying a call option in this situation limits your risk to the amount paid for the option in the first place. However, the profit opportunity is unlimited before the option expires if the market rallies. If you are interested in more information about trading options, check out our tutorials here. You can also read more about option products available from the exchanges at the CME's or ISE's websites.

Your Charts May Be Costing You Pips

Are you using bid charts or ask charts? If you don't know, your chart may be costing you pips.

Forex traders, especially day traders, plan their entries and exits down to the pip. But what if the pip on your chart isn't the pip you think it is?

"Ask" charts are charts that plot their price position based on the ask price for the currency pair. "Bid" charts are charts that plot their price position based on the bid price for the currency pair. Depending on the spread for a particular currency pair, the bid and ask prices may be 2 pips apart or 100 pips aparts---or anywhere in between. So why should you care? Let's take a look at an example.

Imagine you are a day trader and have bought the EUR/USD at 1.3812 because you think it is going to move higher during the next hour or two. To protect yourself, you have set a stop loss order for the EUR/USD at 1.3792 because you don't want to risk more than 20 pips. Also imagine you are using "ask" charts.

You're cruising along in your trade, you're feeling good and suddenly you see the EUR/USD start to fall in value. You watch intently to see if it's going to drop low enough to hit your stop loss at 1.3792. Mercifully, it stops just short of your stop loss at 1.3794 and turns around and head back higher.

You're feeling great until you look at your trading station and see that you've been taken out of your trade for a 20-pip loss. What?! How could that be?! You shouldn't have been taken out of your trade. You watched the EUR/USD turn around before it hit your stop loss.

Unfortunately, you've forgotten one important fact: when you exit a trade on a currency pair you have bought, you must sell the currency pair at the bid price, not the ask price.

For most dealers, the spread between the bid and the ask prices for the EUR/USD is 3 pips. That means the bid price is always 3 pips lower than the ask price. So if you had been watching a "bid" chart instead of an "ask" chart, the chart would have looked like this instead.

The bid price of the EUR/USD actually dropped down to 1.3791, one pip below your stop loss. Since a sell stop order at 1.3792 is activated by the bid price when you have bought a currency pair to enter the trade, you were taken out of this trade.

Had you determined your stop loss by looking at a "bid" chart instead of an "ask" chart, you may have decided to set it a few pips lower, but because you were using an "ask" chart, you didn't, and you got taken out of your trade at a loss.

Don't lose money because you don't know what chart you're looking at. Take a moment and determine if your charts are based on the bid price or the ask price and adjust your trades accordingly.

Right Said Fred - Who is Freddie Mac and why does he matter?

Freddie Mac is the nickname of the Federal Home Loan Mortgage Corporation. You may jump to the conclusion that Freddie is a government agency or quasi-government company like the United States Post Office but that would be wrong. Freddie was chartered by the congress of the United States but is a private enterprise. This company basically buys the best qualified home loans (usually not sub-prime) and wraps them up as Mortgage Backed Securities (MBS) and sells them on the secondary market. When Freddie does that they collect a fee for guaranteeing the loan and they provide more liquidity into the home loan market.

So why do I bring this up?  Freddie reports earnings this week, on Thursday, and the last few reports have been terrible. They  have been reserving almost half of their net-income in a bad debt account. This is important because Freddie only guarantees the best loans. They will only buy sub-prime adjustable loans when the borrower would qualify for the highest rate not the teaser loan rate, which is relatively rare.

This has been major contributor to the the U.S. sub-prime crisis over the past year. Freddie wants to be able to buy more loans but are being prevented by government regulators, which will drive borrowing costs. They are also reserving extraordinary am mounts of reserves for defaults on the best types of home loans. As this has happened the U.S. consumer is hurt by falling home prices, higher borrowing costs (which is really the same thing as falling home prices) and a faster slide from default to foreclosure. All of this has contributed to a very high risk environment.

The question is whether this news release will shock the market on Thursday and if so, how long those ripples will last. Higher risk could definitely impact the forex with a trend reversal and flight to quality. However, there is the possibility that this release will please the market and that the news could be more upbeat than expected. If that were to happen I would anticipate a nice rally in the stock market.

Yields throwing you a curve?

The yield curve is an interesting forecasting tool. If you are not familiar with this indicator, here is how it works...

Yields available on government debt will generally be smaller for short term debt and larger for long term debt. For example, the yield on the 30-year treasury bond in the US is usually a couple points above the 13 week bill. Here is how it works as a forecasting tool. If traders think that the economy is going to contract, yields in the short term will rise and long term yields will fall. If this curve becomes inverted that is a very bad sign. That happened in 2006, 2000 and 1998 most recently. The inverse is also true. If the curve is moving from flat to steeply curved in favor of long term debt then traders are anticipating economic expansion.

This brings me to my point. Over the last few months, the long bond (30-year) yield has risen considerably compared to the 13-week bill. This may be an indication that economic issues in the US are drawing to a close. It is no guarantee but it is useful for long term traders as we seek to set our overall bias in the intermediate term.

For more information about yields, check out our site at www.pfxglobal.com

Chart of the 13-week bill versus the 30-year bond yields

Do You Have Trading Demons?

All of us have trading demons (the picture is actually Saturn Devouring His Son, by Francisco Goya, but you get the point). The story of Dr. Jekyll and Mr. Hyde remains extremely popular today because we all know we have our own Mr. Hydes we have to deal with. My Mr. Hyde is over-confident and has entitlement issues.

You see, I have a problem. I always believe I'm right, which makes me prone to believing my hunches are always right too. Needless to say, in my early days of trading, that cost me a lot of money.

I had to set up rules in my trading, not because I thought they were generally a good idea (which they are) but because I have to have them, or I will blow up my account. It's a good lesson I learned early on.

Unfortunately, many investors never take the time to sit down and evaluate themselves. They'll spend plenty of time evaluating MACDs and Gann lines, but they won't ever look at themselves to see if they are handicapping themselves.

I found that the majority of my problems early on as a forex investor stemmed not from my technical analysis but from my trading personality. I like to make quick decisions, I have a hard time looking away from the charts and letting the trade do its thing, and I have a hard time believing I could have ever been wrong so I chase bad trades. That is quite a list of bad investing traits, I know, but I have learned how to cope with them. I started making longer-term trades.

Longer-term trading keeps my Mr. Hyde in check because I'm not operating off of the pressure cooker that is a 1-minute chart like I used to. Daily charts move much more slowly and much more steadily. I don't have to make quick decisions anymore, I don't have any choice but to walk away from my charts to sleep, etc., and I don't have the same urge to chase bad trades. Becoming a longer-term forex investor has made all the difference in the world for my account.

Ask yourself, what are your demons? What can you do to tame your Mr. Hyde? Trust me, while it feels exhilerating to let Mr. Hyde come out and play, your account will get fatter if you keep him in check.