Page 125 - Ultimate Guide to Currency Trading

The Anatomy of a Hedged Directional Trade

The short NZD/JPY trade will capture profits in two ways. The first will be when the high yielding NZD
falls out of favor. New Zealand is usually considered a high-growth economy. If the market senses any
form of slowing growth, high-growth economies such as New Zealand will be one of the first to suffer.
The market will react to the idea of slower growth by beginning to think that the Reserve Bank of New
Zealand (http://www.rbnz.govt.nz) will not raise rates in the future, or worse, will cut rates. This will
cause the currency traders of the world to desire to have a low-yielding currency such as the Japanese
yen more than the NZD, the currency of the possibly slower-growing New Zealand. The JPY will look
more attractive because it is already low yielding, and the thought is that it is so because the economy
has already slowed in Japan. If an economy is already slow, that central bank can lower rates only so
much more. Therefore, there is a bit of a built-in safety net in owning lower-yielding currencies.

You will also achieve a diversified position by shorting the SEK and going long the USD. The
Swedish krona is sensitive to the risk sentiment and is considered a growth currency. This is because
Sweden's economy is small and tightly focused on banking and industry. Sweden's banks historically
have had a large customer base in the Baltic nations. These Baltic nations are economically stable, but
derive much of their prosperity from heavy industry. Additionally, Sweden is home to both Volvo and
SAAB-Scandia. Both are car, truck, and heavy machinery manufacturers.

With this in mind, if the world's stock traders and economists think the world's economies are
doing well, and they are willing to continue to push up the price of stocks because they have a strong
risk appetite, then the SEK will do well also. The reverse is also true. A bad stock market leads traders
to think a bad economy, which leads traders to think: sell the Swedish krona. With a long USD/SEK,
you will also be capturing the upward movement of the dollar, because money flocks to the USD in
bad times. The USD is considered one of the safest currencies to own, and many people want to hold
dollars when the world's risk sentiment increases, like after the stock market falls.

What trades would I place if the market was expected to go down?

Most of the examples in this book are to set up a trade that would earn money if the
QUESTION stock market were to go up. If you would like to capture gains when the markets go

down, just short the growth currency and go long the low-yielding, safe-haven
currency.

The third and final diversifying position is a short EUR/CHF position. In this case you would
capture the increase of the Swiss franc over the price of the EUR. Since the euro is the main currency
of Europe and is frequently traded against the USD, the play between the euro and the Swiss franc can
be very easy to predict. In this example, money will flow out of the euro and into the Swiss franc as
the world's traders take risk off the table and move their assets into the ultrasafe franc. Even though
you could short the euro against the U.S. dollar, a more predictable gain would be to short the euro
against the Swiss franc.