Until 2022, Forex used to be an asset class with low volatility. However, rising inflationary pressures across the developed world prompted a growing number of central banks to tighten monetary policy aggressively, almost in lock-step.
In turn, this has brought about wide swings in currencies, in particular currencies of countries whose central banks were less willing or able to increase interest rates. For example, the Euro is down approximately 14% year-to-date against the US dollar, as the European Central Bank has raised its benchmark rate at a slower pace than the Federal Reserve.
Here are 5 ways to take advantage of currency swings, in ways you may not have thought of.
Trade Forex Through a Forex or CFD Broker
If you have an interest in Forex trading, you may already have opened an account with a Forex or CFD broker. These brokers make it possible to trade tens of currency pairs, across major and minor currencies, with or without leverage. Some Forex brokers have created their own trading platform, but most now support MetaTrader 4 and 5.
All currencies trade in pairs. If you expect the US dollar to continue to strengthen against the Euro, open a long EURUSD position. And if you expect the US dollar to weaken against the Euro, open a short position instead in that instrument. This is similar to the way you would go about trading stocks.
However, there are other ways to take a view on currencies, that don’t require you to open an account with a Forex broker. We’ll discuss these next in detail.
Convert Currencies Through a Traditional Broker
If you already invest through a traditional stock broker, your online trading account will have a base currency, in which your account balance and fees are labeled. However, we’d encourage you to check whether your broker allows currency conversions through its platform, as some brokers allow you to keep a balance across different currencies.
Currency conversions aren’t free. You’ll incur a currency conversion fee, which may be on par with that charged by banks. So make sure to enquire about currency conversion charges upfront, and ensure that the expected profit more than outweighs your broker’s fees.
Trade Stocks With Currency Exposure
You could also take a view on currencies by trading stocks with currency exposure. For example, many American tech companies derive a large amount of their revenues and profits overseas. A strong US dollar will reduce the dollar value of their overseas earnings, and cause a mechanical fall in expected earnings per share, all else equal. This prompted Microsoft to downgrade its revenue and earnings outlook in July 2022.
You could take advantage of this by closing any long positions you may have opened in stocks with overseas exposure, and by opening a short position in the said stocks, if you have a particularly strong view on this. Shorting is the process whereby you sell something today that you don’t own, with a view to buying it back at a later date for less.
Trade Options on Currency Pairs
Last but not least, you could trade Forex through currency options. You could use options to hedge a spot position or speculate on changes in exchange rates through long or short positions.
Currency options are similar to traditional equity options, to the extent that all Forex options strategies are built around vanilla call and put options. They have expiry dates, and also come in two flavors: American and European. For example, you may exercise an American option at any time prior to expiry, whereas you may only exercise a European option on expiry. The existence of an expiry date implies that you’ll need to be right about your call either at or before the option’s expiry.
For example, you could buy a call on the EURUSD currency pair if you expect the US dollar to appreciate against the Euro. You’d pay the option’s premium upfront, with a view to breaking even once the pair’s exchange rate has risen above the sum of the strike price and the premium. You may also be able to sell your option prior to expiry for a profit if the option’s premium has risen in value by then, perhaps as a result of a rise in the underlying.
Read More: How to Build A Forex Trading Model
Trading currencies isn’t without risks, especially at a time when central banks are taking aggressive steps to fight inflation. Before taking a view on the future direction of a currency pair, ask yourself how you would feel if your trade moved against you, and carefully consider the levels at which you will close your position for a profit or a loss. Importantly, you should only ever invest money that you can genuinely afford to lose, and use leverage with caution, as leverage will increase both your potential profits and losses.