There are trillions of dollars traded daily in the currency markets. Most stock traders miss out on this never ending and always volatile opportunity since they don’t understand how the market works.
Not to mention that many stock traders believe that a special forex trading account is needed to access this often lucrative market. While traders can use a specialized forex account, there is really no need to do so.
Believe it or not, currencies can be traded in a regular stock market account if you know how
The first step to profiting from the forex market as a stock trader is to understand exactly how the forex market works. Let’s take a closer look.
The most unique thing about the Forex market is it is not single symbols that are traded, but rather pairs of symbols.
This can appear confusing to the beginning Forex trader, even those with experience trading stocks or futures.
Questions come to the new Forex trader’s mind such as; just what am I trading, should I be buying or selling a particular pair if my market outlook is calling for a weaker/stronger dollar, and just what does a pair represent?
In order for any currency to be valued it needs to be compared, or valued against another currency.
Therefore, in Forex, a pair represents the buying of one currency and the simultaneous selling of another.
Let’s take the most popular of the currency pairs as an example, the EUR/US DOLLAR or EUR/USD. Let’s assume the pair is valued at 1.3500. This means that is takes $1.3500 in USD’s to buy one EURO.
The first currency is known as the base currency and the second is called the quote or transactional currency.
The pair is valued in the quote currency; therefore, in this example the pair is USD. The trader is selling DOLLARS and buying EURO when going long the EUR/USD pair and Buying DOLLARS and selling EURO’s when shorting.
If you are bearish on the US DOLLAR, you would go long the EUR/USD pair.
Bullish the dollar, the trader should short the EUR/USD pair. The same concept applies to all the pairs.
Pairs are divided into major and minor rankings. The major pairs include those that contain the 7 major currencies that are USD (US DOLLAR), EURO(EURO), JPY(YEN),GBP,(POUND), CHF, CAD and AUD.
Now that we have a better understanding of exactly how the forex market works. What is the best trade right now in the forex market for stock traders?
Let’s clarify what is meant by a strong or weak U.S. dollar. Understanding these terms is the first step in understanding how to trade the currency market.
The accepted definition of these terms can be found in Investopedia.
A strong dollar occurs when the U.S. dollar has risen to a level against another currency that is near historically high exchange rates for the other currency relative to the dollar. For example, the exchange rate between the U.S. and Canada has hovered between 0.6 CAD/USD and 1.1 CAD/USD, if the current exchange rate is at 0.7 CAD/USD, the American dollar would be considered weak and the Canadian dollar strong. A strong U.S. dollar, on the other hand, is one that is trading at a historically high level, such as 1.1 CAD/USD.
The terms strengthening and weakening have the same context but refer to the changes in the U.S. over the period of time being mentioned. A strengthening dollar is one in which the U.S. dollar has increased in value compared to another currency. This means that the U.S. dollar now buys more of the other currency than it did before. A weakening U.S. dollar is the opposite as it means the U.S. dollar has fallen in value compared to the other currency – making the U.S dollar buy less of the other currency.
The terms strong, weak, strengthening and weakening can be used to refer to any currency.
The current global economic environment is screaming to go long the U.S. Dollar. A strong greenback is great for the economy and for traders who jump on the trend.
- Climbing Interest Rates
The Federal Reserve has made it very clear that rates will start to climb soon. We detailed this major economic change in a previous article.
Suffice to say, the majority analysts believe that climbing interest rates will create strong headwinds for U.S. equities. Right now it’s not a question of if rates will climb, it is a question of when.
The good news about climbing rates is that they will increase the value of the greenback. Savvy traders can ride this trend by going long dollars.
The above long-term interest chart through 2010 shows how rates have fluctuated over time. Today, with rates near zero, the environment has been extraordinarily bullish for U.S. stocks. This is about to change. While stocks will likely decline, the USD is almost guaranteed to advance on the back of higher rates.
- Relatively strong U.S. economy.
The U.S. economy has beat most international economies in recent years. This is particularly true in regard to developed economies that are our biggest trading partners in Europe and Japan. A solid economy has aided U.S. financial markets and made the U.S. a smart destination for foreign capital.
This “safe haven” sentiment for the U.S. economy will help lift the greenback.
3. Improving trade balance.
The U.S. trade balance has developed dramatically, thanks in large part to the flourishing U.S. energy production and resulting drop in oil prices that has reduced U.S. imports and increased exports.
4. Improving budget deficit.
By strengthening the U.S. balance sheet, a shrinking budget deficit is bullish for the dollar.
Now, How Can You Profit With This Information?
Thanks to exchange-traded funds or ETFs, traders no longer need a specialized forex trading account or futures account to access the benefits of currencies.
Right now, the trade that makes the most sense is to go long the U.S. dollar.
This can be done multiple ways via ETFs, but my favorite way is he via the PowerShares Deutsche Bank U.S. Dollar Index Bullish Fund (NYSE:UUP).
A look at the chart for UUP indicates that major technical resistance at the 200 day simple moving average has been violated on the upside.
Many large investors and institutions watch the 200 day SMA to trigger long entries
In addition to UUP, there are multiple other trades which investors can consider in anticipation of a strengthening dollar.
My next favorite way to profit from the climbing greenback is to short the euro. I like doing this via the ProShares UltraShort Euro ETF (NYSE:EOU).
This ETF is known as an inverse ETF. This means it is built to obtain investment results which are twice the inverse (minus two times) of the daily performance of the euro.
Because it is leveraged, investors must understand that their losses will be twice as significant as the decline of the euro against the dollar on any given trading day.
In addition, it is designed for daily results, not long-term results. This is because the ETF is rebalanced to maintain the leverage. This prevents it from tracking the underlying instrument on a long term basis.
Boiled down, leveraged ETFs are designed for day trading and not long term holds. Therefore, only use the leveraged ETF’s for very short term trading.