Forex Trading With ETFs

03/03/08 09:49:10 AM

by Mike Carr, CMT

A limited number of ETFs offer new opportunities to stock traders.

Security: N/A
Position: N/A

One advantage of forex trading is a high degree of leverage. Many brokers offer leverage of 100 to 1, and some even more. This means great gains are possible on small investments. But what some see as an advantage, others see as a disadvantage. With a small move against the trader, visions of great gains can quickly become the reality of great losses. With full leverage, a very small move can wipe out an account.

Many brokers advocate paper trading, but trading legend Jesse Livermore thought it was a waste of time. He thought that until you won or lost real money with your ideas, there was no way of knowing the value of any trading idea or strategy. CurrencyShares ETFs offer traders a chance to test their ideas with real money, without a high degree of leverage. Although only four currencies are currently offered, spread analysis allows you to build synthetic pairs and create a roster of 12 additional trading candidates.

Although forex traders have a large number of options available to them, at times they still need to turn to synthetic pairs. If a trader thinks the worst currency in the world is the Icelandic krona (ISK) while the strongest is the Australian dollar (AUD), they want to go long AUD and short ISK. If this pair is not available, they can build a synthetic pair using a common base currency like the US dollar. By buying the dollar–AUD pair and shorting the dollar–ISK pair, they have created the position they wanted.

In Figure 1, we see a chart of the CurrencyShares Australian dollar ETF (FXA) with the relative strength compared to the CurrencyShares British pound ETF (FXB) in the lower half of the chart. We generate trading signals from the relative strength. After bottoming in August 2007, we would have been long FXA/short FXB until October. We could reverse the trade at that point, going long FXB and shorting FXA. In January 2008, the relative strength broke out of a rectangle, and we would be long FXA/short FXB again.

FIGURE 1: AUSTRALIAN DOLLAR TRUST. In this chart, all signals are generated using the relative strength line in the lower portion.

Graphic provided by: Trade Navigator.

Using just these ETFs, traders can easily build a relative strength matrix in Microsoft Excel and monitor trading opportunities. With real money on the line but with limited risk, this technique offers traders an opportunity to develop skills in forex trading with real money but less risk.

Mike Carr, CMT

Mike Carr, CMT, is a member of the Market Technicians Association, and editor of the MTA's newsletter, Technically Speaking. He is also the author of "Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing," and "Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends."