May 26, 2014

    Good time to invest in USD

    BUOYED by last month's positive jobs data, the best so far this year, investors have good reason to believe that the US economy will grow stronger in the year ahead.

    Non-farm payrolls rose by 288,000, with the private sector registering 273,000 new jobs. The unemployment rate fell to 6.3 per cent - the lowest since September 2008.

    Recent data has also showed a rebound in goods production, housing construction, personal spending and goods consumption.

    The Federal Reserve is, likewise, showing greater confidence in the economy, through the tapering of its quantitative easing measures.

    One can expect the US dollar (USD) to strengthen alongside these positive economic fundamentals, said Phillip Futures forex dealer Kwah Wee Hong, thus presenting an "opportune time" to invest in the greenback.

    There are two primary ways to do this. For the novice, trading the US Dollar Index (USDX) futures is one option, said Mr Kwah, while those with a bigger risk appetite can consider spot forex.


    The USDX is a benchmark for the international value of the US dollar. It comprises a basket of six weighted currency pairs, of the USD versus other major currencies such as the euro (EUR), British pound (GBP) and the Japanese yen (JPY).

    "The USDX is relatively easier to understand, compared to trading individual currency pairs, as in spot forex. For example, if you trade the JPY/USD you should have an understanding of both the US and Japanese economies," said Mr Kwah.

    Because it is a basket of currency pairs, the USDX is also diversified and hence less volatile than currency pairs.

    While perhaps a boon for the risk-averse beginner, the speculator who likes to see bigger currency movements will gravitate towards the spot forex market, Mr Kwah noted.

    However, both products are also similar in several ways.

    As derivatives, the USDX and spot forex are margin traded, which means that with a small capital, investors can own a contract of a much larger value. But while the gains are increased through leverage, the losses are also magnified.

    Although dollar futures have a fixed margin, in spot forex the margins vary according to the currency pairs being traded.

    There is also a high amount of liquidity for both products, which means that investors are able to square off their positions whenever they need to.


    There are six popular major currency pairs which are traded on the market: EUR/USD, USD/JPY, GBP/USD, Australian dollar/USD, USD/Canadian dollar, and the USD/Swiss franc.

    Let's assume an investor is bullish on the EUR/USD, which has a current spot rate of 1.3900. With a margin of around US$300 (S$375), he buys one contract of EUR/USD with a notional value of US$10,000.

    If after the first day of trading the EUR/USD moves up with a settlement price of 1.3950, the investor would have made a profit of US$50. This is derived by multiplying the notional value of US$10,000 with the change in the EUR/USD rate of 0.005 (1.3950 minus 1.3900).

    A mark-to-market is performed at the end of each trading day, to credit the profits or debit the losses.

    Should an investor have insufficient funds in his trading account to maintain his position in the market, he would get a call from his brokerage to do a top-up. In investor-speak, this is referred to as a margin call.


    Future contracts for the USDX are listed on a quarterly basis.

    Let's assume the same bullish investor buys one June contract at an index of 79.55.

    The contract value is calculated by multiplying US$1,000 with the index value, which in this instance is US$79,550 (US$1,000 x 79.55).

    However, due to leverage, the investor will need an initial margin of only around US$1,050.

    Suppose the index value goes up to 80.55 at the end of one trading day. At the daily mark-to-market, the investor will make a profit of US$1,000. This is derived from multiplying US$1,000 by 1.00 (80.55 - 79.55).


    In deciding which currency pairs to trade in, Mr Kwah said investors should "test and hone their skills" in markets which they are familiar with, and which have high liquidity.

    Mr Kwah advises investors to keep up with the news and pay close attention to the Federal Reserve's policies, which will reflect its confidence in the US economy.

    "The Federal Open Market Committee's meetings... are followed by public announcements that are important for investors and consumers. One can think of these meetings as the government equivalent of a quarterly earnings report, only with much higher stakes," he added.