Forex Trading for the Sophisticated Investor

Sooner or later, every high-asset investor participates in the equities, bonds and commodities markets or at least seriously considers these choices. Currency trading seems more arcane but bears adding to any portfolio.

Money is fascinating in and of itself. In addition, however, foreign exchange trading catapults the savvy investor to the realm of international import-export transactions and investment flows. Hence the volumes are huge, reliably estimated as close to $3 trillion every single trading day and the opportunity for profits correspondingly immense. But so is the downside, if ill-considered placements are made.

Setting aside market sentiment, one makes better-informed decisions based on the political developments and economic indicators that are reported for each country in a currency pair. Herewith a syllabus of sorts for Political Economy 101.

If you want to take a position on the dollar vis-à-vis the renminbi, for instance, you must pay attention to the growth of gross domestic product (GDP) in both China and the United States. GDP is a quick read on how well the economy of any nation is growing. Usually reported as a quarterly or annual growth rate, GDP is the sum total of wealth-producing activities in agriculture, industry and services.

The more consistently an economy expands and, within limits, the faster it does, the stronger will consumer confidence be and the firmer the belief of fund managers in one of the currencies in the forex pair. As well, economic growth implies capital inflows by investors interested in capitalizing on growth opportunities, thereby firming up that country's capital account and foreign reserves. Among other things, the foreign reserve of trading partner currencies is a bulwark against forex speculation designed mainly to put the dollar or renminbi in play.

In turn, accelerated investment boosts employment and increases demand for raw materials and services, a cycle that strengthens the prospects for continued growth down the road.

On the demand side, GDP reportage might reveal the status of personal consumption expenditures. Together with government outlays and total investment activity, consumer spending is the engine that drives economic activity. The well-informed forex investor may hear or read bits and pieces of the consumer spending tableau: housing starts, car sales, sales ex-manufacturer and in-store, purchases of luxury goods. What matters is putting all these together into a coherent reading of consistent growth in consumer spending.

In medium-size or developing economies, consumer spending has the additional value of giving the investor a solid clue whether domestic demand is growing fast enough to offset over-dependence on exports.

Interest rates comprise a fifth indicator. When the Fed (or other central monetary authority) decides to raise bank reserve requirements, money supply shrinks and interest rates rise. Or interest rates might be used to hold inflation in check. So a Tokyo fund manager dissatisfied with the 1% interest on his yen deposits might decide to park his funds in U.S. 2-year bonds which bear a coupon rate of 4.5% and on which the yield has risen lately. All other things equal, such thinking would strengthen the dollar and weaken the yen.

On another level, dissatisfaction with interest rates may spotlight the gains to be had in forex trading. Correctly guessing that mixed news on the economic front would hurt the U.S. dollar, buying $1 million worth of euros on April 3, 2007 would have earned a profit of close to $30,000 by month's end or an annualized return of about 25%.

At the end of the day, one can expect capital gains in forex trading by attending to political economy factors such as GDP, interest rates, consumer confidence and spending.