Apart from investing in stocks and bonds, I also invest in currencies (or exchange rates), particularly when significant geopolitical events occur. Just to be clear that I’m not a Forex trader and I don’t engage in day trading. Since I have a full-time job, I prefer holding my position over several months or years instead of making frequent transactions. In this article I’m going to do a brief introduction about foreign currency market, explain relevant macroeconomic principles, and show you how I did it.
What is it?
Forex means foreign currency and exchange. Forex market is open 24 hours a day, five and a half days a week. Currencies are traded worldwide in the major financial centres of Tokyo, Hong Kong, London, New York, and Singapore—across almost every time zone. Forex markets are world’s largest and most liquid asset markets.
Why do I invest Forex?
Forex markets are among the most liquid markets in the world. So, they can be less volatile than other markets, such as real estate.
Also, participants can use forex to hedge against international currency and interest rate risk, speculate on geopolitical events, and diversify portfolios, among other reasons. Personally, I usually use it to speculate on geopolitical events.
Ways to do it:
You can do it either in spot market or derivatives market.
If you are a beginner, I suggest you start from spot market, because it’s easier to understand. The spot market is where currencies are bought and sold based on their trading price. The derivatives markets (forwards, futures, swaps, and options) tend to be more popular with companies or financial firms that need to hedge their foreign exchange risks out to a specific future date.
Things you need to know before doing it:
Before trying to make currency investments, you need to understand some basic macroeconomic principles. We start from figuring out what factors affect currency price.
The currency price is determined by supply and demand directly. It’s simple to understand -- if the currency supply is high and demand is low, its value will go down.
Then we need to figure out the factors that affect currency supply and demand:
Interest rates & Inflation: if the interest rate in country A goes up, compared to that in country B, in short term, the value currency A relative to currency B will go up. Because higher interest rates tend to attract foreign investment, increasing the demand for and value of the home country's currency. However, we need to be able to identify if this is just “hot money inflows” or long-term foreign investment. The former will disturb market stability, but the letter is good for the country’s development.
Also, Central banks often raise interest rates in response to rising inflation to cool off an overheating economy. But, if inflation rises too quickly, it can devalue a nation's money quicker than interest rates can compensate savers.
Economic performance: GDP growth and currency value often move together. GDP is often used by national central banks when deciding future impacts on interest rates.
Global Trade: A country's balance of trade between imports and exports can be a crucial factor in determining currency value as well. That is because greater demand for a country's products means greater demand for the country's currency as well. Analysts often cite a country's balance of trade and net trading position (net import vs. net export) as a signal of that currency's strength.
Geopolitical sentiment: geopolitical events can impact various currency pairings differently depending on their nature.
Price speculation: If many speculators sell the currency in the forward market, this will signal that the currency is overvalued, and people will begin selling the currency in the spot market.
How and why I did it:
Trading app I use: Trading 212
Target currency pairs: GBP/CNH & USD/JPY
Transaction details: I use two graphs below to show you the details.
My strategy for the first GBP/CNH transaction was fairly straightforward: I was speculating on the Brexit panic by buying low and selling high. Btw, It’s important to stay calm and decisive when doing investments. Here’s a piece of advice to help you with that: before I made every transaction, I always set price ranges. If the price touched the bottom line, I would buy it immediately instead of sitting on a fence and hope to get a lower price. If the price reached my ceiling, I would sell it without doubt instead of being greedy. Also, I use statistics and my instincts when setting the ranges. I developed my instincts by reading history, learning from others (famous analysts and investors), and making real transactions by myself.
The UK officially withdraws from the EU on 31 January 2020. After that, GBP decreased sharply but still above 8. I set the price range of 8~9. I thought GBP/CNH would drop below 8. GBP, however, recovered after reaching 8.161. So I bought it at 8.3016 when I realised it was unlikely to drop below 8. When it reached my ceiling of 9, I sold it for $9.0056. In less than three months, from 24 March 2020 to 09 June 2020, I generated a total return of 8.48%
My strategy behind the second GBP/CNH transaction is based on the huge inflation gap between UK and China. China's inflation rate has remained low, largely because China has benefited from the cheap Russian oil imports, whereas the UK government has been unable to control the rising inflation rate despite multiple increases in interest rates. GBP's value relative to CNH decreased as a result. Therefore, I bought in GBP when the exchange rate dropped below 8 on September 5, 2022. However, I expect UK’s inflation rate will go down in coming year because some of the production difficulties businesses have faced are starting to ease and people have less money to spend, therefore, less demand for goods and services in the UK. As a result, I expect GBP/CNH will increase and I'm still holding my positions.
The reason I bought USD against JPY on September 24, 2021, is because the gap in interest rate between Japan and the U.S. has widened. The Bank of Japan continues its massive monetary easing, keeping long-term interest rates, the benchmark for corporate borrowing and mortgage rates, low. The U.S., on the other hand, is tightening monetary policy to contain historic inflation, and interest rates continue to rise.
However, given that Japan is one of the United States' top trading and investment partners. The depreciation of the Yen will be somewhat mitigated by an increase in U.S. imports from Japan as the value of the Yen falls. Besides, the US interest rate hike is probably going to slow down. Therefore, I expected the yen will recover and sold it on April 24, 2023, realising 21.22% total return.
Nobody is able to predict the exact movements of asset prices all the time, so don’t be obsessed with being 100% right. Making the right forecast for the big pictures, sticking to our investment plans rather than being impulsive and greedy, and learning from mistakes should be our goals.
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