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An asset in FX.

Summary: Investors in the Gulf have a lot of misplaced reservation in the FX markets, largely due to the lack of awareness as to how the markets work and the risks involved. BME attempts to break down the barriers.

T he FX market across the Middle East has historically been used for hedging purposes, according to Claus Nouveau-Nikolajsen of ADS Securities. Many investors feel that they have little or no knowledge about trading currencies, and have not entered this investment area. But this could be a mistake, he warns.

Currencies are the most liquid and most highly traded asset in the world. They trade 24 hours a day, "In 2011 the The euro/dollar: The world's most popular pair

annual daily level of FX transactions broke the $5 trillion level, more than all other asset classes grouped together, and FX trading volumes across the Middle East continue to build on a daily basis," he adds.

Some investors have been lured by online FX trading platforms promising 'quick and high returns' only to have their investments vaporised before they knew it.

Kathleen Brooks, EMEA Research Director at FOREX.com warns that due to the size of the market, prices can move very quickly, "It is important to adopt proper risk management techniques to ensure your downside is protected in case the market moves against you. However, because the market is so large this also means there are lots of opportunities to trade."

TURNOVER

Forex kicks off trade in Sydney and slowly moves around the world; to Tokyo, Middle East, London and New York. Daily turnover in the world's currencies comes from two sources:

1)Foreign trade

2)Speculation for profit

Foreign trade accounts for roughly five per cent, according to Forex.com. This is where companies buy and sell products in foreign countries and convert the profits from foreign sales into domestic currency.

Speculation accounts for the lion share - 95 per cent.

REWARDS

Claus Nouveau-Nikolajsen says, "At ADS Securities we show clients how to trade and how to develop FX trading into an important part of their investment portfolio. There are three things which should attract Middle East investors to FX trading."

The first is that it is suited to investors who are already experienced at trading other asset classes. "Knowledge and skills can easily be transferred. If traders are already tracking market fundamentals and environmentals they will find these factors influence currency pairs in the same way, " he says.

"Secondly, Forex and bullion are extremely liquid asset classes, which allow investors to enter and exit when they want. Unlike stock markets, in recent years, if you want to close your position you can".

"Finally, in normal operating bounds, FX currency pairs normally trade within a two per cent variation on a day-to-day basis. You can access this spread without the dramatic volatility that has impacted other asset classes," he adds.

"To trade in this way requires a clear strategy, consistent execution and long term approach to creating Alpha. But the good news is that you can create significant returns even when equities and real estate investments are falling and fixed income product returns have become non-existent."

MARKET INFLUENCERS

Brooks says there are many market influencers to consider when investing in currencies:

Fiscal Policy

This affects growth and GDP, and growth figures can move FX markets.

Monetary Policy

This is key for FX as monetary policy determines interest rates and interest rates help to determine a currency's value.

Governmental surpluses/deficits

This can weigh on a currency as it can affect credit ratings. A deficit can weaken a currency if it weighs on a country's creditworthiness, likewise cash surpluses can boost ratings and a currency since it can make a country more creditworthy.

Balance of trade statistics

This is important due to the above - government surpluses and deficits. However, a country with a high trade surplus may want a weak currency to ensure their exports are protected and their economy can grow.

Inflation

This is important since inflation can determine monetary policy and thus interest rates. There is a sweet spot for both interest rates and inflation, whereby a currency can strengthen when inflation is rising. If inflation is too high it can choke off growth and this is a negative for the currency. Likewise, deflation tends to be currency negative, unless the currency is a safe haven like the yen.

Political stability/ instability

Since FX cuts through politics, economics and even social issues political stability is important to help a currency strengthen. Instability tends to cause currencies to weaken as it causes uncertainty, and investors hate uncertainty.

Market psychology

People talk about herd psychology and don't fight the trend in FX markets. Technical analysis is essentially a way to tell which levels the market is looking at, hence why you tend to see currency movement around big support and resistance levels. Thus, market psychology can be a big driver of FX.

It is important to adopt proper risk management techniques to ensure your downside is protected in case the market moves against you

CURRENCY PAIRS

Forex currency pairs are grouped into three categories:

1) The majors are the largest, most traded and most liquid of the currency pairs.

2) The minors are the commodity currencies, like the Australia dollar/ US dollar and the Scandinavian currencies.

3) The crosses are the currency pairs that do not include the US dollar.

Nouveau-Nikolajsen says, ADS Securities is regularly asked why anyone would invest in the currencies like the euro when Europe is in such a state, "Our reply is straight forward. The truth is that profit may not come from this pair in the short term. But currency in Japan is clearly over priced at the moment, and for Japan to move away from a trade deficit, it will have to export, and it cannot do this if its currency is over-valued. So why wouldn't you want to trade the dollar/yen?"Forex.com spells out the importance of the better known currency pairs:-

NZD/USD: The New Zealand dollar (Kiwi) has been a relatively predictable pair. It is a risk barometer, This pair is a good one to try to detect sentiment in the markets.

Forex and bullion are extremely liquid asset classes, which allow investors to enter and exit when they want

EUR/USD: This is the most widely traded pair, because it makes up such a large proportion of daily FX volume. What happens in this pair can affect other euro and dollar crosses.

AUD/USD: This is also a good risk barometer since AUD is a 'risky' currency and the movement of this cross is a good way to take the 'temperature' of the market and how investors feel about other assets like stocks, bonds etc.

GBP/USD: This pair tends to get sloshed around and follow EURUSD. The pound has mostly been driven by external factors in recent years, thus it is not a good reflection of the UK economy.

DLR/JPY: This pair is where we have seen the most dollar strength since the start of the year. It has a good correlation to US Treasuries, so if the Fed starts to sound hawkish this should be reflected in a stronger USDJPY.

USD/CHF: This pair is popular and used to be the 'ultimate safe haven trade' as the Swissie was bought during periods of riskaversion in financial markets. But now that the Swiss National Bank (SNB) has come in to limit Swissie strength the CHF crosses have been fairly range bound and will likely remain so until the SNB releases its grip on the currency.

Brooks adds that investors need to be aware of the impact of currency intervention, as it disrupts the natural flow of currency markets as central banks get involved and manipulate the values of FX.

"The Swiss National Bank is trying to weaken the Swiss Franc. This can sometimes cause excess volatility as markets test central banks' reserves and nerve to keep currencies weak. For example, the Bank of Japan has tried to intervene in the FX market to weaken the yen on multiple occasions and often failed, which can be very costly."

There is a lesson in this, she adds, "The FX market is so big it can even swallow central banks. Thus it's extremely hard to swim against the tide in the FX market."nBME

INVESTING IN CURRENCIES

Kathleen Brooks investment tips:

1 Have a game plan

Don't just dive into FX. Make sure that you choose your pair carefully and have thought about entry levels and an exit strategy

2 Always use stop-losses

If the market moves against you then you want to know that your downside is protected

3 Dedicate time to trade

FX trading can be tricky and you need to concentrate when you put trades on and think about what pair to trade. You don't want to be distracted and make a mistake

4 Think outside of the box

The FX market is related to other asset markets so if you are trading the dollar and you know that movements in the dollar affect the price of gold and crude oil then you may want to think about trading multi-asset classes at the same time

5 Learn from your mistakes

You are a tiny cog in a giant wheel, so don't expect to be right all the time. A strict risk management policy should be employed when you trade FX

2012 CPI Financial. All rights reserved.

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Publication:Banker Middle East
Geographic Code:70MID
Date:Apr 30, 2012
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