Bright prospects for the pound
THE fog clouding investors' predictions about the performance of major currencies appears to have lifted in recent months.
Key fiscal announcements and economic data released by the Group of Seven (G-7) countries have offered a clearer picture of which trajectories their currencies will likely take.
On the bullish path will be the United States dollar (USD), driven by consistently solid economic numbers, including strong jobs data last month, said Phillip Futures' forex dealer Yu Chung Leong.
The US Treasury yields have also been increasing steadily to around 2.6 per cent, which will further prop up the greenback.
Beating down the same bullish track will be the British pound (GBP), Mr Yu said, when providing an outlook on the currencies of the G-7 countries, which also include France, Italy, Germany, Japan and Canada.
Mr Yu pointed to factors such as healthy inflation, robust housing prices, and Bank of England governor Mark Carney's recent statement that interest rates could be increased soon, as indications of the pound's likely appreciation in the year ahead.
However, a bearish season looms ahead for the euro (EUR), said Mr Yu.
This is due to soft consumer price index numbers that are projected to slide further, and the European Central Bank cutting interest rates and taking the deposit facility rates into negative territory.
With Japan expected to continue its monetary easing policies and to cut the corporate tax rate soon, the Japanese yen (JPY) is also expected to stay weak.
Looking at the G-7 as a whole, Mr Yu said that there appears to be a disparity in the economic health of a few countries in the group, which presents an opportunity in the foreign exchange (FX) market.
"When you trade FX, you are buying one currency and selling another. You'll want to invest in the currency of a strong robust economy, such as the pound, and sell the currency of a weak economy, like the euro," Mr Yu explained.
Currencies are traded in pairs, and the EUR/GBP and the USD/JPY are two pairs investors can look at, said Mr Yu.
In trading the EUR/GBP contract, an investor is trading the appreciation or depreciation of the euro relative to the pound.
With the euro expected to weaken against the strengthening pound, the price of the EUR/GBP contract will also slide, said Mr Yu.
In this scenario, an investor should "go short", which means he should sell the EUR/GBP contract as he believes the price will drop further.
If his position is correct, he can then buy back the contract at a lower price later on, thus making a profit.
Conversely, the USD/JPY is a currency pair which investors should "go long" on. This means buying the USD/JPY with a view that it will rise, and selling it off later at a profit.
HOW IT WORKS
FX trading is done on leverage, which means that with a small initial margin, an investor can buy or sell a contract of a relatively larger value.
Besides passing a trading knowledge assessment by his brokerage, an investor will need to decide whether to trade with a standard or mini contract.
The standard lot is 100,000 of the base currency, so if you are trading EUR/GBP, this is equivalent to 100,000 euros. As margin trading is involved, an investor typically needs to have 3 per cent, or 3,000 euros, to buy or sell one contract.
The mini lot is 10,000, which in this case means 10,000 euros and an initial margin of 300 euros.
Let's say an investor sells one standard-sized contract of EUR/GBP at 0.8000. If the price goes down to 0.7920, he will have made a profit of £800, because the price is in his favour.
This is derived from the difference in the EUR/GBP price (0.8000 minus 0.79200 equals 0.00800) multiplied by the contract size (0.00800 multiplied by 100,000 equals 800).
KNOW THE RISKS
While the gains can be significant, margin trading has its risks, as losses are "amplified" as well, said Mr Yu.
Investors need to have a personal stop-loss, which means setting a level at which they will exit the market to cut their losses, should the trade move against them, he added.
Timing the market is of utmost importance and investors should pay close attention to the resistance and support levels when studying FX movements.
Support is a level beyond which the market typically does not move lower. This is due to more people wanting to buy, but sellers being less willing to sell.
Conversely, resistance is a level beyond which the market typically does not rise higher, as there are more sellers than buyers expected at those levels.
For the next one to two months, Mr Yu puts the resistance of the EUR/GBP at 0.8065, and the support at 0.7880. For the USD/JPY, he thinks the resistance will be at 102.70 and the support at 101.50.
THIS SPONSORED PAGE IS BROUGHT TO YOU BY PHILLIP FUTURES