Spread Betting: Trading EUR/USD
One of the most popular currency pairs amongst spread traders is euro-dollar or EURUSD. According to the Bank of International Settlements (BIS), daily volume of foreign exchange trading has nearly quadrupled since 2001, from $1.2 trillion in 2001 to just below $4 trillion today; of which EURUSD now accounts for 28%. This means that the EURUSD currency pair is one of the most liquid financial instruments you can trade. Bid-offer spreads are typically quite tight and margins are low which makes it very easy to trade in and out of this currency pair.
Spread betting companies are reporting increasing trading volumes on where the euro will move in relation to the dollar as the eurozone crisis unfolds -:
We have witnessed percentage of volumes traded in our euro/US dollar market compared to other markets grow by 160% over the past two years,” says Joshua Raymond, chief market strategist at spread betting broker City Index.
Trade the EUR/USD at Ayondo
Most investment banks still appear heavily bearish on the euro with some banks predicting a rate of $1.2000. At one point, however, the market will become oversold and that may be your chance to take an euro long position. History shows that the EUR/USD reached an all-time low of $0.8115 (15 Jan ‘02) and an all-time high of $1.6036 (14 Jul ‘08) and at the moment we are at the $1.2300 mark.
A characteristic of financial spread betting is that it is just as easy to go long as it is to sell (or short) a currency pair – or perhaps more accurately with currencies, to decide which one you believe is going to strenghten against the other. Placing a forex spread bet is a simple process irrespective of whether you believe the currency is going to go up or down. If you place a rolling daily spread bet (as opposed to a daily spread bet), then you have the added advantage that you are able to roll the position over to the next day and thus gain extra time for your predicted scenario to materialise.
Say you were concerned that the US dollar was strengthening against the Euro, following the problems that various European countries are having; or that the Euro was weakening against a US government supported dollar, whichever way you want to think about it. Or you could take the opposite position, as around half of the traders do for a given exchange rate, and decide that the US dollar was going to fall against the Euro, perhaps because of the continuing high unemployment In the States.
The Euro fell sharply against the dollar on the back of contagion fears that the Greek debt crisis could spread to other European countries. We can see a clear trend of a weakening Euro since the start of the year. Again no surprises here as to why, we have the ECB keeping interest rates at all-time lows, combined with a policy of printing money like it is confetti to buy up sovereign debt and new bond issues, billions spent on stimulus packages, bank bailouts…well you get the picture.
It is worth noting that there are two sides to all currency trades. For instance the EUR/USD is not just about the eurozone. Currency traders may be blindsided by factors impacting the other side of the pair. One notable factor for foreign exchange markets is central bank intervention. This happened recently in Japan and Switzerland, where central banks opted to buy in the currency markets so as to appreciate their currencies against the USA dollar in an effort to retain their export advantage against speculators who were looking for further quantitative easing from the United States, which could drive up inflation. Looking at the Swiss franc for instance this dropped to 1.11 against the euro (September 2011) and then the Swiss National Bank then stated that they wanted the rate to be around the 1.20 level. The Swiss franc then experienced a lot of turbulence but now the market trades in a tight range on either side of the intervention level.
Correlations are frequent when playing currency pairs meaning that the currencies of certain countries are prone to move in a common direction. Taking the EUR/USD and the GBP/USD for instance, these are prone to move in the same direction (although not exactly the same0, albeit the GBP/USD tend to experience a little more volatility than the EUR/USD. However, generally speaking if the EUR/USD is strongly trending in one direction, you can normally expect the GBP/USD to follow the same trend meaning that they are positively correlated.
For certain, the Fed seems happy to weaken the dollar as long as they keep seeing improvements in the labour market and the Fed’s continual quantitative easing pushes aim for this. Traders looking to trade on a longer term perspective may thus choose to bet on the USA dollar weakening against risk currencies like the Euro or even the Australian dollar.
It is also interesting to note that the EUR/USD currency pair does not experience a sharp increase in volatility during the Frankfurt and London opens as opposed to the Pound/USD. The trading volatility of the EUR/USD reaches its peak during the 8:00 and 11:00am EST when the London and Frankfurt exchanges overlap with the New York open. A common mistake that new forex traders tend to make is to take the volatility at the earlier part of the day’s pip movement in London and expect this movement to be replicated later on during the latter part of the trading session (usually corresponding to mid-day New York or the Asian session). This may lead a spread better to enter a trade after the close of the London session only to find that market has subsided as the New York session is the only financial centre that is still open at the time.
Betting against the EUR/USD has been one of the most popular plays during the ongoing eurozone debt crisis problem where the euro has fallen sharply from $1.45 to $1.25 in the past 12 months (which is equivalent to a 2000-point move since these markets are traded to two further decimal places). Some really big hitters at IG Index have reportedly been selling the forex pair at $25,000 a point netting a profit of about $50 million! [Warning: If the forex pair had moved against his position the trader would be looking at a loss of an equivalent amount!]
Of course, the euro is first and foremost viewed as EUR/USD in the eyes of the market, and we are doubtful of how much further the euro can go relative to the US dollar before European officials start to fret about an uncompetitive exchange rate in an environment currently dominated by so-called ‘currency wars’.
Euro/Dollar Spread Betting Example
Spread bets allow trades to amplify movements in either currency in the EUR/USD forex pair. Suppose that the spread on the euro against the dollar is $1.2949 – $1.2951; you could buy at the upper end if you believed the the euro would strengthen or sell at the lower end if you believed that it would weaken. If you took a short position at £1 per point and the euro fell against the dollar by 600 basis points, this would be multiplied by your stake of £1 per point, netting you a tax-free gain of £600. Of course this cuts both ways and you would have suffereed a loss had the euro strengthened against the dollar.
Let’s take an actual example. For instance, at the time of writing the EUR/USD is at $1.2950, and depending on the broker, the spread is listed from 1 to 5. The price you get would depend on the spread betting provider, and might be quoted as $1.2949 – $1.2951. If you go long, or buy the EUR/USD, you are looking for this to increase. You would buy at $1.2951, and you have to make the spread before you come into profit – if you sold straight away, you would only get $1.2949. If the quote went to $1.3150 – $1.3152, you could close the position, and make 199 pips, which if you had staked £5 per pip, or $0.0001, would give you £995.
It is important to note that you can also lose if it goes the wrong way, and you can lose more than the initial stake your broker asks for.
If you wanted to take a short position, you would sell the market. This is saying that you think the number will go down. You would sell at $1.2949, and wait for the price to fall so that you can take your profit.
Trading the EUR/USD Forex Pair
The recent strengthening of the US Dollar against a tumbling Euro has presented the traders with more opportunities to potentially profit from market swings. The EUR/USD currency pair is a great way to get started in spread betting on the foreign exchange market. It is one of the “majors” and very popular, comprising about 27 – 28 % of all foreign exchange volume, more than any other currencies. Because of the amount of trading, it has a small spread, and it also responds well to technical analysis. Compared to the GBP/USD it is relatively less volatile, making it easier to trade for the beginner. However you can generally expect the EUR/USD and the GBP/USD to be going in the same direction as each other 90% of the time, as much of the analysis will be common.
This leads to a note about risk management. Usually you try to size your bet so that moves against you do not have a dramatic effect on the value of your account. If you choose to bet on both the EUR/USD and the GBP/USD, you are effectively “doubling up” and increasing your risk. It’s far better, particularly when you are starting out, to concentrate on one or a few currency pairs rather than trying all of them on for size.
The EUR/USD reacts fairly quickly to economic data releases so it is highly liquid and always moving. Factors that you need to take into account when trading the EUR/USD include the relative interest rate for each currency. For the euro this is set by the European Bank (ECB) and for the States it is set by the Federal Reserve Board, and the meetings to discuss changes are regularly scheduled and watched with great interest. Another major influence on the strength of the currencies is the current economic situation, as spelled out in unemployment figures, balance of trade figures, and inflation, to mention just a few. These factors are easier to determine for the United States, because of the many constituent countries that use the euro, but there is no shortage of information. In particular you need to watch out for manipulations by governing bodies, which have increased with the nervousness over the global economic downturn.
But as USD is one of the most traded currencies – it sits in the most major liquid pairs and is the default international business currency – it is impossible for liquidity and activity to dry up. Nor will movements around the globe cease, meaning the troubled eurozone could see its currency shift substantially against all pairings, while fears about a slowdown in Chinese consumption of commodities continue to pile pressure on a previously firing economy in Australia.
In particular Central bank meetings and comments from European politicians are keenly followed by day traders as they often can lead to substantial price swings. For instance let’s assume that the European Central Bank (ECB) announces a 25 basis point cut to its interest rate. Following such an announcement, how do you trade the euro? The cut might be expected so might be already priced in the currency markets but such interest rate cuts don’t do any favours to the EURO and are likely to result in downside pressure. So if you expected the euro to lose ground against the USA dollar you could go short and sell the EURO against the USA dollar. If the market moved in your anticipated direction, you would make a profit with each pip that the euro depreciated. Of course the opposite also holds true and if the market were to move against your position (i.e. the Euro rose against the USA dollar) – this would result in a loss for every pip the euro appreciated (rose) against the USA dollar.
It may seem a good idea to anticipate announcements, and take a position on the currency to profit from any large moves. If you are a novice, the general advice is not to do this because they are unpredictable elements that can catch you out unless you are quick to react. For instance, often the market will anticipate news before it is announced, so even if you deduce correctly the news before it is public, you may be caught out by a move in the opposite direction to that which you expect. Even if you wait until the move starts after the announcement, it may suddenly reverse and catch you out.
As the EUR/USD is not as volatile as some currency pairs, you can set relatively close stop losses and protect your principal. It responds well to technical analysis, and as mentioned is not too twitchy, giving you a chance to react to its moves. The EUR/USD is recommended for the spread better who wants to get involved in the Forex market.
The euro appears to be a huge paradox. How can a currency in crisis be so strong?
The headlines scream that the euro still risks a breakup, yet the currency is at very strong levels if you look back the last 10 years. A currency in crisis collapses. The euro hasn’t and it won’t. So what model explains this? A collapsing euro will collapse from the edge to the centre. Weak countries would be turfed out of a collapsing euro, peeling members back towards the bastion of Germany. If the euro weakens however the Eurozone is strengthened because the weak periphery gets the updraft of devaluation and a dose of inflation to oil the wheels of commerce, taxation and debt.
The euro would not be in crisis until it hit 1 to 1 with the dollar, then perhaps it would be fair to say the currency had a problem. I watch the pound / euro and it is obvious that the euro can fall far before the pound is back to old fashioned, long-term levels.
So a weakening euro is a sign of the end of the euro crisis as an acute marketbusting event. The inflationary fix is in, and the euro will fall steadily for a long time. The European Central Bank (ECB) will lend money to banks who will buy sovereign debt. The governments then spend the money on their public sector, monetizing as they go, creating inflation to evaporate away their liabilities.
It’s a sustainable model, especially as the UK and US are doing the same thing. Only when there is Eurozone inflation over 5% and the euro is 1.50 or worse to the pound will there be any question of whether there is a crisis. For now, the euro will be the winner of the devaluation game.
The euro has benefited from the influx of long term refinancing option repayments (LTRO) that have reduced the size of the ECB’s balance sheet.
Add to that the loosening of monetary policy and prediction of more quantitative easing both here in the UK and in Japan, plus the US’s continued monthly asset purchases and you can see that it’s a classic case of less means more. It’s simple supply and demand, really: as the quantity of euros dwindles while the quantities of the other major currencies increase, the euro’s exchange rate rises.
Traders were also becoming more relaxed about the euro’s long term future; the fundamentals might still not be particularly strong, but it didn’t look like the eurozone and its currency was going to disintegrate anymore. ‘The euro’s surprising strength has simply been a reflection of reduced fears that the single currency was set to disintegrate. Consequently, investors have been busy unwinding earlier safe-haven positions in long gilts. The ECB’s policies, designed to give the currency and its markets a breather, are working for the time being.
In addition, the ECB’s recent statement that it believes inflation risks in the eurozone to be ‘broadly balanced’ has wooed potential investors back. This is a classic signal to markets that the ECB will not cut interest rates in the eurozone anytime soon. Of course, this comes at a time where seemingly every other central bank in the world is looking at loosening monetary policy (quantitative easing in the UK and US, inflation targeting in Japan etc) and hence investors have flooded into the euro.
There remain many challenges facing the US economy as it attempts to move towards a stronger growth environment. Tackling the fiscal deficit will require a political consensus. However, there will be few who want the country to return to recession. The European sovereign debt crisis will also have a big impact on the US economy because of its importance as an export market. Whatever happens, there seems to be both positive and negative signs for the US economy, but it is clear that it still has further to travel on the route to recovery.
Spread Betting on the EUR/USD
The EUR/USD is a great place for the novice in the foreign exchange markets to start their spread betting, as it is well behaved and responds to analysis. The current quote for a daily bet on this currency pair is 12,930.0 – 12,932.0 with IG Index. Because of the order of the currencies, if you think the euro is going to rise or the US dollar is going to fall, you want to place a long or buy bet; if you expect the euro to drop, or the US dollar to rise, you want to short or sell this pair.
For example, say you placed a long spreadbet for £6.50 per point, because you think the US dollar is going to fall against the euro. If the dollar did fall, which is the same thing as the euro going up, you might choose to close this bet when the quote was 13,146.5 – 13,148.5. You can easily work out how much you won.
First, you work out how many points you made. The spreadbet was closed at 13,146.5, up from the original 12,932.0. Therefore the difference in points is 214.5. For the size of bet you placed, this works out to £1394.25.
The other scenario is when you placed the same bet, but the euro goes down/US dollar goes up, and you are faced with a losing bet. One of the secrets of successful financial trading is to get rid of your losers quickly, before they get too large. Perhaps you close the bet when the quote from your spread betting company drops to 12,893.2 – 12,895.2. Now you can work out how much you lost.
You opened your currency spreadbet at 12,932.0, and it closed at 12,893.2. That’s a difference of 38.8 points. At your chosen stake, the bet has cost you £252.20.
Note that this is a daily forex spreadbet, which usually means there is a small charge on long bets every evening when they roll over the bet to the next day. Provided you do not hold the open bet for a month or more, this is usually not too much.
Betting the other way, if you think that the euro will fall or the dollar rise in relation to it, you might bet £4.50 per point at a price of 12,930.0, looking for the quote to go down. If it goes down to 12,723.7 – 12,725.7, you could close your bet for a profit. Note that in this case the daily charge should be in your favour, though again not very large. You might find that your spread betting provider credits your account each night on a short bet.
Calculating how much you won, you gained 12,930.0 less 12,725.7 points, that is 204.3 points. Note that a short bet closes on the higher price, and opens on the higher. At your stake of £4.50 per point, you have won £919.35.
Once again, this could have been a losing spreadbet and you would have exited it quickly once you realized. Perhaps the index went up to 12,972.4 – 12,974.4, and you closed your currency bet for a loss. You have lost 12,974.4-12,930.0, which is 44.4 points. With a stake of £4.50 per point, you have lost a total of £199.80.
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