|
Regular readers of our weekly Trading Tutors newsletter will be familiar with Andrew Page’s excellent articles on investing in shares using the DividendKey approach for income and growth.
The same concepts are also applicable to the currency markets, as I will explore in this week’s article with an example on the Australian Dollar.
The Australian Dollar touched the magic 1.0000 level against the US Dollar last week, reaching parity with the greenback for the first time since the currency was floated. I didn’t think it would reach that level this year, though having said that, it only broke that level by a mere 0.0003 points on October 15, stayed there for a few moments and then fell away. At time of writing (Wednesday October 20, 2010) the Australian Dollar is trading back down at 0.9693 against the US Dollar.
So how can we look to adapt investment concepts to the currency markets?
Well, as investors and traders, we generally buy shares for one of two reasons – growth or income. If the share price rises in value, we make money from the growth of the share. If the company makes a profit and pays us a dividend, we receive income. Capital Gains, or growth, are only locked in once the share is sold, but income is paid for as long as you hold the share (or as long as the company makes a profit).
The same logic can be applied to the currency markets. Let’s take the example of the Australian Dollar against the US Dollar (FXADUS in ProfitSource).
Let’s use $100,000 as a starting point. Take the following “hypothetical example.” You believe the US Dollar will weaken substantially in the long term as the Federal Reserve tries to “print” its way out of trouble. You decide you will invest $100,000 into Australian Dollars traded against US Dollars to take advantage of this.
With many brokers offering margin rates as low as 0.5% (that’s half a percent!), you could technically enter a $100,000 trade or investment in this currency pair for as little as $A500 margin.
Now before you go rushing out to load up on currencies at these fantastic margin rates, be aware that many an FX trading account has been destroyed by the abuse of leverage. Consider “restricting” yourself to 5% or 10% leverage to give your position more breathing room. Also, remember that many people enter a share investment without having an appropriate exit strategy if things go wrong. If a currency trade or investment made on high leverage goes against you it can be a lot worse than a share trade gone wrong. Make sure you calculate your risk before entering a position.
Let’s say you buy Australian Dollars at 0.9000 and the currency moves up to 0.9900 (Note: This is an example, not a recommendation!) This would mean one Australian Dollar moves from buying 90 US cents to buying 99 US cents. This is an increase of 10% in the price of the Australian Dollar, so your $100,000 position would have increased in value by 10%, or $10,000. Not bad for $500 margin!
This is the same effect that a rising share price would have. If you bought a share at $10 and it went up to $11, you would make money in the form of a “capital gain”. In other words, you have profited from the “growth” of the currency price.
As discussed in my recent article “Carry Trades”, which Safety in the Market students can view in our Trading Tutors Newsletter archives, there is also an “interest component” to this investment.
Interest is calculated on this position at the following interest rates:
Cash Rate of Australian Dollar = 4.50%
Cash Rate of US Dollar = 0.25%
We are long on Australian Dollars, so we RECEIVE interest on the position at approximately 4.25% or $11.64 per day. 4.25% is a better return than many share dividends will provide.
(Note for a full explanation on this, please review the article “Carry Trades” in Trading Tutors Issue #377).
This interest is calculated and paid daily, allowing you to benefit from additional income from your investment.
While this is just a hypothetical example, if you are looking to diversify your investments, then why not consider including currencies in your portfolio?
In next week’s article I will discuss techniques that can be used to analyse the long-term trend of a currency, and discuss potential strategies that might be considered by the long-term currency investor!
Be Prepared!
Mathew Barnes
|