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FOREX - PLAY BOTH SIDES - LONG OR SHORT
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If one wants to take advantage of a price decline, one of the advantages that the forex market has over equity markets is that there is no uptick rule as exists in the stock market; short selling in forex is similar to that in the fu tures market. By definition, when a trader goes short, he is selling a cur rency with the expectation that the price will drop, allowing for a profitable offset. If the market moves against the trader's position, he will be forced to buy back the contract at a higher price, resulting in a loss on the trade. There is no limit to how high a currency can go, giving short sellers an un limited loss scenario. Theoretically, a short seller is exposed to more risk than a trader with a long position; however, through use of stop orders, traders can mitigate their risk, regardless if long or short. It is imperative that traders are well disciplined and that they execute previously planned trades, as opposed to spontaneous, spur-of-the-moment, emotionally driven trades. There are obvious benefits to short selling. This aspect of the forex market allows traders to profit from declining markets. The ease of selling contracts before buying them first is in contrast to typical stock trades. Market prices have a tendency to drop faster than they rise, giving short sellers an opportunity to capitalize on this phenomenon. Similarly, prices will often rally gradually with increasing volume.

As prices begin to reach a peak, trading volume will typically taper off—a signal to short sellers to initiate a trade. When a reversal does occur, there will typically be more momentum than for the corresponding up move. Volume will increase throughout the sell-off until the prices reach a point at which sellers begin to back off. The concept here is represented in detail in this book and is a powerful tool for swing and position traders. Even day traders will benefit from knowing volume analysis. It is important to know where to get the daily volume information and how to apply this information to foreign currency trading. I will share this with you shortly.

HEADLINE TRADES

The BBC commonly refers to the British Broadcasting Corporation; but in the forex market, it is trader's nomenclature or slang for the Big Boys Club : banks, brokers, and corporations. And there is a fourth group: large hedge funds. Each one has made its mark in history using foreign currencies. Two milestone trades made headline news. These are the famous curency trades, both of which took advantage of taking short and long positions. Let's look at the hedge fund world when famed financier George Soros “broke” the Bank of England. He placed an estimated $10 billion bet that the British pound would lose value, and he won the bet! How about Daim lerChrysler, the parent company of Chrysler and Mercedes Benz; it reportedly made more money in the forex market that it did selling cars! Imagine explaining to your boss that you made more money hedging and trading for eign currencies than doing what you do best, building cars.

Another milestone event is as recent as early 2005. This involved Warren Buffett the founder of Berkshire Hathaway (the fourteenth-largest

U.S. company, according to the July 4, 2006 , issue of Fortune magazine). When the financial media was pounding out news stories that the dollar was in trouble, Warren made a statement that he was heavily short the U.S. dollar. Unfortunately, once he made that announcement, the dollar gained value and rallied for most of 2005. If you did not do your own research or homework and blindly followed his advice, things did not turn out so well for you.

In the remainder of 2005, the dollar moved higher against most major currency pairs. What turned the market around? Some of the events that drove the dollar higher were dictated by monetary policy as the Federal Re serve continued to raise interest rates. Then there were economic, geopo litical, and political developments on the domestic front that influenced the dollar's value. For starters, the Homeland Investment Act (HIA) was passed. The HIA is part of the 2004 American Jobs Creation Act and was in tended to entice U.S.-based multiconglomerate corporations to bring money back into the United States . The window of opportunity for companies to take advantage of the HIA benefits prompted companies to increase the pace at which funds are repatriated to the United States . Since compa nies had only until the end of 2005, many analysts suspected that compa nies would rush to repatriate foreign profits by year's end and that there would then be a high dollar demand to convert foreign currencies. Geopo litical issues arose during the summer of 2005 when there were riots in France as a result of less support for the euro currency. That contributed to a very poor market sentiment and a lack of confidence in the euro. This was grounds for foreign investors to make a flight to financial safety, selling their currency to buy U.S. dollars. The tone was essentially dollar positive and euro negative, which is a result of a change in political views and shows how consumer sentiment can have a negative effect on a currency. I said earlier that technical analysis will be your “bread and butter” for profiting in the forex market; but you still need to be aware of fundamental developments, economic reports, and the times when these reports hit the newswires. As this section shows, fiscal policy changes can drive markets in new directions.

What may have contributed to the dollar rally in 2005 and hurt Mr. Buf fett's position was the fact that other players may have been preying on his position. Berkshire Hathaway, Inc., is without a doubt a high-profile player. So when Warren Buffett announced he was going to cut back speculative positions against the U.S. dollar after losing profits due to surprising dollar strength, the buying to cover his shorts boosted the dollar. Keep in mind that Mr. Buffett had bet that the dollar would continue losing ground, as it did in 2004; he felt the massive U.S. current account deficit would be dollar negative. But instead, monetary policy dictated otherwise, as the Federal Reserve continued to raise interest rates. That was helping to drive demand as the interest rate differentials widened. In its third-quarter report in 2005, Berkshire Hathaway said it had cut its foreign-currency exposure from $21.5 billion to $16.5 billion. That was a significant amount of selling foreign currencies and buying U.S. dollars.

As you can see from the Dollar Index weekly chart in Figure 1.3, on a

U.S. Dollar Index Contract (monthly bars)

year-to-year basis, the dollar did make an outstanding run. However, that rally fizzled out in 2006. Also, keep in mind the dollar was at a high of 120.80 back in 2002; so depending on where Mr. Buffett was shorting the dollar, he could still be in a lucrative or profitable position. When I was wrapping things up for this book, the Dollar Index had managed to decline near the multidecade lows, and investor sentiment remained longer-term negative on the dollar. In addition, if you look at the longer-term price direction dat ing back since the inception of the Dollar Index contract, the Dollar Index is in a descending or declining channel.

The focus of this example is how shifts in monetary and fiscal policies can and do dictate price swings in the market, as happened in 2005 and 2006. Furthermore, foreign currency trading has become an acceptable asset class and valuable trading vehicle for the large multinational corporations. Just for your knowledge, the July 4, 2006 , issue of Fortune maga zine listed the top-10 largest U.S. corporations as ExxonMobil, Wal-Mart, General Motors, Chevron, Ford Motor, Conoco Philips, General Electric, Citigroup, American International Group, and International Business Machines. Funny that 30 percent of the top-10 businesses consisted of energy companies. I found this intriguing; Microsoft was ranked number 50 and Intel number 51. Who was number 100, you ask? John Deere. I think you can see the trends of investment flows and which sector is the leader as represented by the amount of a company's revenue growth. In 2006, the leader was British Petroleum!

Back in late 1999, money poured into technology stocks. In late 2003 and 2004, money poured into home builders. Then in 2005 and 2006, money poured into energy stocks, and not just for short-term trading but also for long-term investment opportunities in exploration and research and devel opment for new oil fields and infrastructure repairs of pipelines and re fineries. The most important terms to remember here are money flow and sector leaders. Following money flows, sector leadership among corpora tions can help you to determine where we are in a business cycle. We will talk about how these two concepts are important factors to monitor when trading foreign currencies. The relationships between how and where money is being made and which industry it is being made in directly impact foreign currency values and can help you in your trading decisions.

Money flows into one sector and out of another. If consumer demand is in technology, as was the case in the middle to late 1990s, then the U.S. dollar is strong. If demand changes to commodity-based products, such as crude oil, gold, and construction materials, the Aussie and Canadian dollars will appreciate. Australia and Canada are both producers of such com modity products as gold and lumber; and since Canada has vast reserves of tar sands, its currency benefits from higher crude oil prices.

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