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About Currency Trading

In today’s article, I will be deviating a bit off of the beaten path and talking about a foreign exchange (better known among traders as forex) trade idea I’ve been personally developing in recent history.

But first, allow me to better introduce forex for the novice, which will actually help me out being that I myself am not the biggest expert on this asset class.

Yet.

In the most elementary yet informative sense, foreign exchange trading is much like how we view trading stocks, bonds and other asset classes, except instead of buying a stake in a company (stocks) or debt (bonds), one is buying (and selling, don’t worry I’ll explain momentarily) a pair of global currencies. While this base concept might be rather easy to grasp, a little more detail is surely warranted, as even though the thousands of self-proclaimed gurus out there make it seem effortless, flashing bootleg screenshots of their profit and loss statements on Instagram (don’t fall for it, they are one of the reasons traders and investors get a bad wrap), it isn’t as easy as mindlessly buying low and selling high. 

I’m afraid the forex greats such as George Soros, Stanley Druckenmiller and Paul Tudor Jones didn’t make a habit out of flexing on the ‘Gram.

At any rate, forex trading ultimately entails exchanging one currency for another, betting on the value (appreciation or depreciation) of one currency against the other. An example of this could be someone going long (or buying) the euro relative to the US dollar. In this particular case, you are telling the market that you expect that the value of the euro will increase in value in relation to the dollar. In any currency trade, continuing on with this example, you are in essence going long one and short the other, in this trade showing a bullish stance towards the euro (buying the euro) and a bearish stance on the dollar (selling the dollar), with the trade pair on any given platform being formally denoted as EUR/USD.

One of the biggest challenges in forex, besides hitting home runs, let alone getting to first base at all, is developing a strong enough thesis to convince you well enough that the currencies will diverge with another and the euro will go up and the dollar will go down. It can be quite taxing to put together a thesis and stick to it, as there are a multitude of external factors in this uncertain world that push prices up and down, some more historically prominent factors including interest rates, inflation, relative economic growth, trade balances (or imbalances) between nations, politics, other degrees of monetary policy, and heck, even natural disasters can play a hand in unexpectedly shifting prices around.

Nevertheless, in an effort to make this all feel a little less daunting for this particular trade, you might be convinced that the European Central Bank (ECB) is on its way towards tightening its economic policy (i.e., tapering inflationary concerns through raising interest rates) while it is your opinion and/or understanding the Federal Reserve is intent on bringing rates down and maintaining a less hawkish, more dovish posture, or perhaps you might simply think that economic growth in Europe is set to increase sooner rather than later, with economic momentum waning in the United States, which more often than not leads to a stronger euro and less strong dollar. Additionally, other schools of thought such as banking on lower inflationary pressures prevailing in Britain could be a rather logical and direct reason to want to go long the GBP, as lower inflation almost always inherently means a currency is better able to maintain its purchasing power, not to also consider the general market and trade landscapes both in Europe but also outside of it. For instance, if there is a trade surplus (i.e., more coming in than coming out of Europe), this typically results in a stronger euro, with investments flying into the continent and affirming economic activity and expansion in the region (and the heightened demand for euros rather than other currencies).

These are just some of the primary rationales behind being objectively bullish on a currency, and I am just about to tell you why, upon performing my own research, I actually believe going long the British pound, or the GBP, specifically through a currency trading lens of GBP/USD (again, buying British pounds, selling US dollars) is a good trade to ponder.

Trade Rationale

First and foremost, economic growth in the United Kingdom has been fortified in more recent quarters, specifically, with gross domestic product (GDP) growth actually beating expectations in Q1 2024, expanding at a rate of 0.7% instead of the expectation of 0.4%, directly indicating that general economic activity in the region has been far from docile, but actually expanding with many analysts perhaps sleeping at the wheel. Additionally, as it also relates to reports, the widely held consensus is that the Bank of England is more aligned with many other central banks in that it is enforcing more controls on taming inflation, one primary way in which a central bank typically goes about doing this is by raising rates, which subsequently attracts investment from other nations, acting as a means of bolstering the value of the GBP. Also, besides bolstering the value of the currency through rates, the mere narrative that the ECB itself is focused on keeping inflation at bay usually translates into perceived currency stability for others, yet another incentive for relevant market participants of all types to buy pounds. Even more, as it relates to the Bank of England, particularly its Monetary Policy Committee (MPC), it has outlined (in multiple instances) its commitment to pursuing monetary policies and specific measures thereof that target eventual rate stability, also more often than not translating into currency stability. 

I also think it is worth lastly mentioning that, although one would be foolish to adamantly believe that past performance directly enforces future results, out of all of the G-10 currencies, the GBP has been the only member currency that has outperformed the US dollar this year.

Final Notes on Forex

Unlike most retail traders in the equity space (i.e., stocks), many who find themselves in the foreign exchange markets trading currencies employ leverage, and take it for what you will, it is my opinion that this is an especially dangerous practice in this market, as currencies movements and swings can become quite severe and volatile, as currencies are quite sensitive to unprecedented events or even mere market rumors regarding national economies, which really means that you could have the most airtight, well-constructed investment thesis of all time, but one report from the Financial Times could kill your position and then some.

Traders, beware.

Also, while I am still on my soapbox, many engaged in forex trading use technical analysis, meaning they predominantly study past price movements and attempt to accurately determine future movements based on previous ones. 

I have never been a staunch proponent of trend trading.

Primarily, while I think the notion of comparing similar previous market environments and events with one another isn’t a bad idea, basing how you deploy capital based solely on past movements is irresponsible, and that’s me putting it politely. 

While there are many other considerations, this is a trade idea that I’ve been developing for a relatively brief span of time and if nothing else, a new topic and asset class to chew on.

DISCLAIMER: This analysis of the aforementioned stock security is in no way to be construed, understood, or seen as formal, professional, or any other form of investment advice. We are simply expressing our opinions regarding a publicly traded entity.

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