Shares digital

The greenback’s slide continues, which could mean opportunities for traders who play their currencies well. Helen Castell is poised for action

Since late January, the dollar has been back on its slippery slope. On 3 March alone, it dived to a record low against the euro, was its weakest for three years against the yen and continued to sink against sterling. And many currency strategists think this could be just the beginning of a new mid-to-long-term trend.

To most Brits, a weak dollar conjures images of New York shopping trips and wads of holiday cash. But with some well-timed trades, currency shifts can earn you more than a cheap pair of jeans.

So if fears of a US recession have left your stock portfolio looking shaky, is it time to swot up on your technical analysis and for once make some money out of America’s misfortunes?

Housing, credit, oil

The reasons for the dollar’s recent downfall are complex. Hit from all quarters by recession warnings, bank failures and the possibility of more interest-rate cuts. To make things worse, it looks as though Europe and the rest of the world are bearing up better.

From a fundamental perspective, ‘the sentiment on the US dollar is very weak,’ says Sandy Jadeja, chief market strategist at ODL Securities. ‘Obviously the decline in the housing industry has had a negative impact on the dollar itself, but there are two other obvious factors – the credit crunch and rising oil prices.’

Coupled with some strong European data, there is a growing perception that the ECB will not follow the US to cut interest rates,’ notes Catherine Hardiman, head of dbFX EMEA. ‘The potential’s forming in people’s minds that maybe Europe’s decoupling a little – it’s not going to slow so fast.’

This year’s massive interest-rate cuts in the US have also weighed on the dollar against other currencies, notes Tony Celentano, head of sales and business development, UK at E*TRADE. ‘It’s not that appealing for investors to purchase because it’s not very high-yielding.’

From a technical perspective too, the dollar seems set on a downward spiral. ‘If you look at the overall dollar index, that’s been in decline for the past several months, and at the moment there are no technical indications that show the dollar has anywhere near bottomed,’ says Jadeja.

On January 25, sterling weakened against the dollar and came right to a Fibonacci 38% support level at $1.9589, he notes. ‘From that point we are likely to see sterling gain strength against the dollar … and we may push back towards the high, to just above $2.’

At the end of February the euro broke through new technical resistance levels against the dollar, and as this story was being written traders were waiting to see whether it was a true break or a short-term spike. ‘If it’s a true break, then the euro-dollar’s really in uncharted territory,’ Jadeja said at the time. ‘It’s difficult to call where the top might be – whether it’s going to be $1.52, $1.55…’

For the trend to reverse, and the dollar to start to strengthen against the euro, ‘we would need to see a confirmed break below $1.4457,’ where the currency hit a ‘pivot low’ on 8 February , Jadeja says.

Selling dollars, buying other currencies

The trend has been playing itself out for a long time. The US dollar index, which tracks the dollar against a basket of other currencies by value, has been on a long-term slide, falling from 100 points when it was created in 1973 to 76 last November, notes Celentano.

And if investors think it will slide still lower, the most obvious trading strategy would be to sell dollars and buy euros or other European currencies such as sterling, says Robert Gray, head of institutional UK at SaxoBank.

‘You’re starting to see some trades being put on to look for further dollar weakness,’ says Hardiman. Typically targeting levels of around $1.55 against the euro, positions currently being taken are still short term but extending beyond standard day trades, she says.

So if you’re considering making a similar play, how should the novice FX investor go about it? How do currency markets work differently from stocks and commodities, what are their attractions, and what do investors need to watch out for?

Foreign exchange markets are vast, fluid and fast-moving – which can be scary but also offers a rare chance to trade on a professional playing field. And with a choice of spot plays, CFDs and spread bets to access the market, more retail investors are piling in.

Retail revolution

Massive liquidity and new online trading systems mean that retail investors can now trade FX on an equal footing with the large institutions and corporates who used to monopolise the market, says Hardiman.

‘We’re seeing a growth right now of retail investors moving from stocks to currencies,’ adds Jadeja. While many investors have recently lost money on stocks – often burned on their assumptions that the market could move in only one direction. With currencies ‘there are no bear markets or bull markets, there’s just movement. If they’re looking for volatility and they’re looking for a good range movement with good trend directions, currency offers that.’

Before you dip your toe into FX it’s worthwhile swotting up on some new trading techniques. Much more than with stock markets, currency traders rely heavily on macro-economic data, but even more on technical analysis – scouring charts for signs that a currency could be set for a spike or a slide.

Technical analysis for currencies uses the concept of resistance levels, arguing that once a currency breaks above or below certain levels from which it has historically stalled or bounced back, the currency will generally keep moving in that direction.

Technical analysis lends itself naturally to currencies, says Jadeja. ‘First of all, it’s a highly liquid market, so there’s going to be a higher volume of people trading. And with the advent of internet technology, the lower cost in trading software and analysis, you find that currencies work extremely well to Fibonacci levels.’

The fact that professional traders – who continue to dominate the currency market – have access to professional charting packages also means that these charts tend to call the market, he notes.

‘Support and resistance levels often work purely because everyone’s got the same data,’ agrees Gray. ‘It’s a self-fulfilling prophesy. However, why not take advantage of it?’

Currency events

Generally, ‘currencies react to political and economic situations, stocks tend to trade on fear and greed, and commodities trade on supply and demand,’ Jadeja notes. ‘And right now we have a lot of economic and political situations on the news, which are hitting the currencies. Presidential elections in the US, turmoil in the Middle East, high oil prices – they all have a mid-to-long-term impact on currencies.’

One benefit of relying on macro-economic information is that an investor usually knows in advance when to expect it, says Celentano. ‘You know what Bernanke is going to talk, you know when the non-farm pay-rolls are going to come out.’

Traders can choose to take a punt on what the data will reveal, placing trades in advance, or can wait for information to come out and keep an eye on a pair’s support levels, he says. ‘If it breaks those levels then you can jump on the bandwagon.’

Markets can, however, move very erratically immediately after key data releases or economic announcements such as non-farm payrolls, cautions Jadeja, meaning novice traders should stay away while the more experienced could try their hand at break-out trading.

‘If you’re an absolute beginner, avoid trading around non-farm payrolls – because you will literally get whip-sawed,’ he warns. And even if you do have experience, it’s safer to wait until 15 minutes after the announcement, then take the high and the low of the past 15 minutes’ price bar, and trade the break of the high or the low, he says.

‘Once the noise has died down, you want to look for a settlement,’ he explains. ‘And once the market breaks the high of the past 15 minutes’ bar, chances are it will continue to go in that direction.’

Other possibilities

A weaker US dollar is not of course a given, and even if it is set for mid-term decline, retracements can occur.

The dollar’s inverse correlation with oil prices means that any future slide will depend partly on oil prices’ continued growth. In the short term, though, that isn’t guaranteed, notes Jadeja. Although oil prices seem hell bent on a long-term climb, ‘technically I think that $103 to $106, at least for the short term, may be a resistance level in the oil market,’ he says. And if oil prices stall at that level ‘that could help strengthen the dollar.’

‘Even while you’re trading on dollar weakness, some protection against a short-term strengthening can be achieved by simultaneously buying the US dollar and selling the Australian dollar, which is considered overly strong right now,’ says Gray. Investors will also be able to profit from the interest-rate differential between the high-yielding Aussie and the low-yielding US currency, he explains.

Another classic hedge for investors looking to sell the US dollar is to buy gold, he notes.

And of course, there is also a school of thought that says a turnaround for the dollar could be just around the corner.

‘Lower US interest rates, which make the dollar much lower-yielding, are one reason why investors would not want to own the dollar right now,’ says Richard Cunningham, managing director at City Index Advisory.

However, US budget deficits are starting to be narrowed, ‘and if anyone’s going to come out quickly of what might already be a slowdown, it will be the Americans,’ he says. ‘Because they are the ones who are most aggressively trying to reinflate their economy.’

‘We’re beginning to anticipate the end of the big dollar downtrend we’ve had for the past five years,’ he says. And ‘if that happens, the dollar could put on as much as 10% really quite quickly.’

No one said that currency markets weren’t high risk. But compared with the record volatility in other asset classes this year, FX is starting to look less frightening.