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Riding the forex rollercoaster

Thu, Oct 16 2008, 12:18 GMT
by Betsy Waters

dbFX.com from Deutsche Bank

The past few weeks have been some of the most challenging I have seen in my 25 years working on Wall Street. Not surprisingly, the bad news and volatility that’s been occurring in the credit and financial markets has also spilt into the foreign exchange (forex) markets as well – and we’re seeing significant volatility across currency pairs, particularly where the US Dollar is involved.

Here’s proof. Looking at the daily price movement in EUR/USD from 5 PM NY to 5 PM NY time, we have, over a number of years, calculated the average daily price moment of the currency pair in a day Until this month the highest price movement differential was 1.55 per cent reached in September 2000. On average, the daily movement in price of the EUR/USD tends to average 1 per cent a day. but in the last few years we have had less volatility with narrower daily movements; in 2005 it was as low as 0.87 per cent, in 2006 – 0.73 per cent; 2007 – 0.60 per cent and year to date for 2008 - 0.98 per cent. However, looking at the month of September the average has significantly increased to 1.67 per cent (as at end of September 08), and up even more to 1.88% as of Oct 13, a marked difference from its average, and a reflection of the high volatility in the forex market currently.

But of course, with greater volatility comes better trading opportunities. Not only does volatility create wider spreads, but also more spikes in the market; enabling investors to make a decision on the future direction of a currency pair. But it also means higher risk, which makes it more important than ever to be well prepared before you start trading. For example, when you enter a trade you should have pre-set expectations for where you think the market will go (profit levels) and where you will get out if you are wrong (stop loss).

The extreme conditions in the credit markets are creating an inverted yield cure (where short term rates are higher than long term rates) in the US for the first time since the 1970s and from a forex perspective, this means you will see massive swings in the day-to-day roll rates on your Forex trades. The ‘Daily roll’ rate is the interest rate you earn or pay each day when you hold a currency overnight.

In short, volatility brings market movements, which brings the opportunity not only for returns, but for losses as well. So it’s vitally important you plan your trades carefully and understand the impact the activity in the wider market is having on the forex market. Forewarned is fore-armed after all.

Published on  Thu, Oct 16 2008, 12:18 GMT

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