Now everyone can be a currency speculator
Traditionally, the world of currency trading was reserved for financial institutions and professional traders. But things have changed. Today anyone with a bit of spare cash can access a mechanism to speculate on currency crosses.
In 1992 the Bank of England ran into a policy brick wall. While it dithered on raising interest rates and stalled on floating its currency, it left the door wide open to attacks by currency speculators. And George Soros took full advantage. On a single day – Black Wednesday – Soros profited to the tune of $1 billion on a massive short position in sterling.
Today anyone can speculate on currency crosses. One popular method is currency futures.
Currency futures are a new derivative product offered through the JSE's Yield-X. Private investors can use these financial instruments to trade a variety of exchange rates over a period of time. Since 31 March 2008 Yield-X has offered four currency futures contracts. These are the Dollar/Rand, Euro/Rand, Sterling/Rand and Australian Dollar/Rand.
Trade, speculate or hedge
Hedging is probably the most sensible application of a currency future. It is the practice of protecting an existing currency exposure against future foreign exchange fluctuations. An importer that purchases goods from Germany (in Euro) and has to pay for the consignment in three months time could 'insure' against a weakening rand by going long (buying) a Euro or Rand futures contract. Once this hedge is in place the importer is protected whichever way the rand goes. If the rand weakens he pays more for the goods; but makes profit on the futures contract. And if the rand strengthens his futures loss is compensated by a decline in the rand invoice amount.
Profit through speculating
But private investors are probably be more interested in the prospect of making profit from short-term currency movements through trading or speculating. There's nothing like the rush of making a few thousand rand as the rand fluctuates against the dollar, Euro or pound! We'll use a Dollar or Rand futures contract as an example. Let's say you think the rand will strengthen against the dollar. You go short (sell) 10 Dollar or Rand futures contracts at R7.6045 (Yield-X provides a price when you complete the transaction). Because each contract gives you exposure to $1 000 your total exposure in this trade is R76 045. The market maker will expect you to deposit an initial margin (approximately R310 per contract) to open the position. For 10 contracts the deposit will be R3 100.
If everything goes to plan and the rand strengthens to 7.4045 you will be able to close your trade by buying back the 10 Dollar or Rand futures. You make a profit of R2 000 – being the difference in the opening and closing exposures (R76 045 less R74 045). And that's a great return on an initial margin deposit of only R3 100.
Not for the faint hearted
Of course things don't always go this smoothly. If, in the above example, the rand weakened against the dollar, you would have lost money. The market maker assesses your trading profits and losses on a daily basis – and requires that you deposit additional funds to cover these losses as they occur. And such losses can quickly add up.
Currency future trading is not for the faint hearted. Take it from Soros: "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."
