Spread Betting: Trading AUD/USD
The Aussie Dollar has been one of the biggest stories in recent years and continues to be a favoured currency in an FX trader’s bag of tricks. The reasons behind this favour are multiple, and given its relatively small supply, AUD punches a little way above its weight. Over the past decade AUD has been progressively strengthening on the back of the economic gains made by the largest island nation on earth. Then came the global financial crisis and AUD gained against pretty much every major (and often minor) currency.
Spread betting on the Australian dollar versus the US dollar [Aussie dollar] is an interesting prospect. The Australian economy is worth study, because it acts very differently from the Western economies that we are used to. The Australian dollar, sometimes called the “Aussie”, has been around since the 60s, when it replaced the Australian pound, a leftover from the British Empire. It is ranked as the fifth most traded currency in the world, with the US dollar being ranked number one.
One advantage of the Australian dollar is that the Australian government tends not to intervene too much in the currency exchange market, which means that any analysis is not disrupted by sometimes unpredictable government action. This means that the currency is able to reflect the global sentiment of Australia’s economic prospects in its daily movements. The Reserve Bank of Australia tries to keep the rate of inflation at a modest 2% to 3%, and it appears that this is reasonably achieved without too much manipulation. For instance, the Australian dollar dipped in 2008, but recovered strongly in 2009 and 2010.
AUD is a commodity-bloc currency; as such it can be used as a proxy trade for the Chinese growth outlook. AUD is particularly sensitive to Chinese data and it tends to be very volatile around the release of such indicators as Chinese PMI data. So, for investors looking to trade a currency with a tight correlation to Chinese economic conditions, the AUD is a popular pick.
The other factor which you need to take into account when trading on the Australian dollar is that it is a commodity linked currency, with the price of commodities having a marked effect on its value. As such you can use the Aussie as a proxy to trade your view on commodities without taking any position in the underlying commodity markets. It is also worth noting that you can get some good swings when trading a commodity currency like the Australian dollar. When the gold spot price moves sharply in one direction the AUD/USD and the AUD crosses tend to follow. This is because higher gold prices can help support the Australian dollar since gold is a key export market in Australia. Gold can be a lucrative, albeit risky market to trade due to its high volatility and if you are interested in day trading the metal but wanted to avoid the higher risk you could trade AUD currency pairs instead. There is a similar pattern with the Canadian dollar.
From a trader’s perspective, the Australian dollar is a useful asset to acquire particularly when commodity prices like metals are rising, global demand is strong, Chinese and Asian growth is healthy and the Australian economy is benefiting from these factors. The dependence on emerging market is now so strong that the Aussie dollar is now mainly a play on China so any risks of a China slowdown will put pressure on the currency and point to further Aussie dollar weakness.
Mining stocks’ profitability will be directly connected to Chinese demand and the underlying price of the commodities. If you believe that the Chinese slowdown will persist and idea could be be to short the currency of one of the main commodity exporters to China – Australia. This is a proxy hedge, but the growth of the economies are correlated. That said, holding a short Aussie position could be expensive to finance due to the high swap rates incurred, as a result of interest rate differentials. In fact, for the past year (2014), the Australian dollar (AUD) has outperformed the US dollar largely due to the cost of carrying a short trade on the Aussie currency which makes it expensive for traders to short in the medium term. Australian interest rates are presently at 2.5% while US rates at zero means that any short trade incurs a negative carry meaning that it costs traders to have a short position.
The Australian economy has been slowing in keeping with its most important trading partner, China recently. Some economists believe it shows signs of ‘Dutch disease.’ This phenomenon occurs in nations that experience prolonged periods of relative wealth – the most noteworthy occurrence took place in the Netherlands after oil was discovered off its coast – as the population gets too comfortable, spends too much, does not work enough and they eventually spiral into economic turmoil.
If you think that might happen or for any other reason you don’t fancy taking a punt on AUD, there are other options available. Alternatives to AUD include those currencies that are tied to commodities. ZAR for its exposure to gold, CAD, NOK, and NZD – although this is tied to agricultural resources, such as milk rather than hard commodities. These currencies all have the ‘bellwether factor’.
It is also interesting to note that the AUD is preferred over a number of other currencies since its yield on cash deposits is normally higher than that available in, say euros, yen or US dollars. The S&P500 is also linked to the Aussie; particularly since both the Australian dollar and the S&P500 offer a relatively high interest rate. Demand for the currency is also affected by the same things that drive corporate profits so both will tend to move in tandem.
As the international currency, the US dollar has a special place in Forex circles. America is not subject to the constraints of other countries, as the US dollar can be printed to manufacture more value. In the long run, this leads to higher inflation and has resulted in some dire warnings from economists, but the 21st century has seen a massive increase in the US deficit, which is attributable in part to two unfunded wars and stimulus spending to combat the global depression.
If you wish to trade the USA dollar weakness, you could take a long spread bet on the Aussie dollar but care still has to be taken because you could be caught unprepared if the Australian economy suffers due to a spike in unemployment figures for instance. Nonetheless, the US dollar still seems to have a secure hold on international trade, and rumours that it might be replaced with another currency such as the euro have not been realized. The dollar is regularly manipulated by the Federal Reserve Bank and its Board, known colloquially as the “Feds”. They meet monthly, issuing obscure statements about the economy and setting the bank lending rate.
As with all currencies, there are certain fundamental factors about the countries’ finances which should be followed so that you can form an overall picture of the health of the economies. You need to look particularly at things like the number of people working and the unemployment claims, as this both shows how prosperous the economy is and also impacts the amount of revenue that the government receives. The rate of inflation is usually addressed by a change in bank rate if it is deemed to be out of a desirable range, so undesirable values can precede an interest rate change announcement. The balance of trade, which must be paid for by currency exchange, gives some indication of pressures on the exchange rate.
Before the turmoil from the global financial crisis, carry trading was a popular strategy and it will come back after the crisis has subsided and volatility decreases. Being short a high yielding currency is one thing…being short a ‘risk on’ currency when the market is negative too, is another…it is really not enough to just rely on technical indicators, fundamentals are also important here.
Recently (mid-2013), the Reserve Bank of Australia has decided to slash the official cash rate from 2.75% to 2.5% which hasn’t helped the Australian dollar particularly as the domestic economy has been slowing and the unemployment rate rising to just under 6%. It is still expected that the Fed will begin cutting its quantitative easing programme which wouldn’t help the Aussie.
Do keep in mind that although with spread betting you could go long or short, a short position against a higher yielding currency such as the Australian dollar will incur a negative carry since you are borrowing in Aussie $ (where rates are high) and putting it in the USA dollar (where rates are lower) so you need to consider this.
As a spread trader, you might notice that the fundamentals behind the Australian dollar follow closely behind some of the big local resource shares in Australia such as BHP and Rio Tinto (which also happen to play a major role in the BHP and Rio). As such it shouldn’t be surprising that the Australian stock market tends to follow the value of the Australian dollar. Of course the Australian economy is not just about mining and energy companies so the correlation isn’t perfect but still… Bullish factor for the USA dollars include a falling unemployment rate and the tapering of quantitative easing. It is also worth noting that Australia is currently experiencing something of a slowdown in its economy and this coupled with a persisting economic slowdown in China might lead to Aussie dollar weakness.
Spread betting on currency exchange rates tends to be a short-term trade, therefore you should use technical analysis to determine the market sentiment from day to day, and direct your bets. Be sure to include realistic stop losses, bearing in mind the volatility of the currency pair, and protect your capital.
Despite the RBA interest rate actions recently, AUD still holds a considerable yield advantage over that of other currencies. If the situation in Europe stabilises, traders will no longer be seeking safe haven trades and will instead be on the search for yield. AUD will be top of that list. If equity markets and commodity prices show some strength over coming months, AUD should be well supported by currency traders. In short, if we have a ‘risk-on’ phase in the market AUD should flourish. Conversely ‘risk-off’ conditions would see AUD again shunned by traders.
Spread Betting on the AUD/USD
The Australian dollar and the US dollar are a good combination for spread trading. They are not the most popular currency pair, but still a major one and one which can react differently from the more mainstream products. The current daily rolling bet is priced at 10,564.6 – 10,566.6, which is a great spread of only two points, giving more scope for profit on the bet.
If you think that the US dollar is weakening in the face of poor economic results, you may want to place a long bet on the AUD/USD (US dollar weakness is the same as Australian dollar strength on this pairing, so requires a long bet). Bet £6.50 per point at the buying price of 10,566.6.
Assuming now that the price goes up to 10,752.3 – 10,754.3, here’s how you can work out how much you have won. The bet is placed for a certain value per point; therefore you first must work out how many points you have gained. The bet went on at 10,566.6, and closed at 10,752.3. That’s a gain of 185.7 points. At £6.50 per point, it works out to £1207.05.
On the other hand, if the price had gone down you might have to close your bet and accept your losses. Say it went down to 10,507.1 – 10,509.1. You work out the point difference, as before, this time taking 10,507.1 from 10,566.6. That’s 59.5 points which for your chosen stake amounts to a loss of £386.75.
For a second example of spread betting on the AUD/USD, let’s consider the case where you think the US economy is turning around and becoming stronger against the Australian one. In this case, you would place a sell bet, also called going short on the currency pair, and might stake £5 per point.
If this bet is a winner, assume you close it when the spread betting quotation goes to 10,392.9 – 10,394.9. To calculate your winnings, first work out how many points you have gained. The bet was placed at 10,564.6, the selling price, and closed at 10,394.9, the buying price. The difference is 169.7 points. You chose to wager £5 per point, so this multiplies up to total winnings of £848.50.
Whenever you place a bet, you must bear in mind that it may not win, and you should know how much you can afford to let it go against you before you close the bet and accept your loss. This is one of the keys to being profitable when you spread bet, as taking a major loss can severely affect your ability to keep on trading.
Let’s say that the AUD/USD goes up after you place your short bet. You might decide to close the bet when it goes up to 10,592.0 – 10,594.0. You should have worked out in advance how large a loss this would give you in general terms, but calculating with the actual figures is done like this. 10,594.0-10,564.6 equals 29.4 points lost. Multiplying by your stake, you have lost a total of £147.
It is worth noting that if you wish to place a short position on the Aussie this will normally cost you money due to the negative carry. (Australian interest rates are at 2.5% while USA rates are at 0%). As such you need to be confident that your risk/reward calculations outweigh your holding costs particularly if you wish to keep the trade open for weeks. One idea is to trade the forward contract in such situations where the spread is a little wider on entry but there are no holding costs when rolling the trade day to day.
In conclusion, AUD is a useful currency and even outside of a pair can be used by investors to make (and lose) some serious cash.
When an investor holds Aussie companies, shorting AUD acts as a hedge against losses. However, if you short resource companies, this doesn’t necessarily follow, as commodities are priced in USD.
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