Some of the Factors I Consider When Trading Currencies

Foreign-exchange trading is a dynamic market where traders are constantly trying to anticipate trends and make informed decisions. Whether a trader is speculating, investing, or hedging, he must consider a wide range of factors such as relative interest rates, inflation, and political and economic events in leading-currency nations. The trader must also understand the psychology of the markets and how various rumors, facts, and events influence other participants.

One of the key considerations for a U.S. trader is the portion of capital flows in and out of the U.S. that is in the form of investment dollars seeking favorable real interest rates. Real interest rates are the nominal rate minus the effects of inflation, and international investors generally look for currencies in countries where economic growth is strong, inflation is low, and real interest rates are high.

Once a trend begins to develop, it becomes a habit, and traders get used to certain price and trading behaviors. For instance, if the dollar is in a bear market against the yen and starts to decline, traders feel safe that the market movement is likely to continue and sell the dollar in the hope of buying it back later for a profit. However, at some point, the market has to assess whether the trend is going to continue. A change in fundamental economic conditions such as a shift in relative interest rates or relative economic performance may influence this assessment and have a large impact on currencies.

An example I spoke about in my book, The Money Bazaar, is the sharp rise of the dollar against other leading currencies in early 1991. Despite a weak domestic U.S. economy, investors became convinced that growth in Europe was slowing and the U.S. recession was about to end. This resulted in capital pouring into the U.S. and a surge in the value of the dollar against other currencies.

Any trader dealing in multiple currencies at that time would have to consider which currency seemed most promising and when to time their activities. Just because the dollar may be strong against some currencies, it could be weak against others. Once a trader arrives at a market view, he still has to fine-tune his decisions by determining the parameters for the market based on prior market experience and price action.

I have a method of buying and selling dollars that has been developed over years of market experience. I determine the parameters for the market based on prior market experiences and certain types of price action that are likely to occur in terms of magnitude of movements.

When I have a bias towards buying dollars, I look for opportunities to buy at levels of support. On the other hand, when I want to sell, it's best to do so when the market is rising towards levels of resistance. Some of these resistance levels might be the same "highs" the dollar reached in the past, while others might have already been touched in recent weeks.

Before making any trade, I have predetermined levels at which I believe my idea is wrong, and I am prepared to liquidate my position if the market reaches that level. I know that if I buy dollars against the euro, and the dollar goes below a certain level, it is not behaving as I expected. In such cases, I move to the sidelines. On the other hand, if the dollar rises to a certain level, I take profits.

The market's inherent validity must always be respected, as the market is always right. This is why I always ask myself, "when should I get in? When should I take profits? And when should I cut my losses?" These questions are part of an ongoing conversation that I engage in, and the process is never as simple as "I think it's going up, so I'll buy it." Instead, I think to myself, "I think it's going to go up, so I'll buy at such and such a price, or I won't buy it at all."