Dear A-Letter Reader:
If you've read our articles over the past three days, hopefully, by now you find the spot market less mysterious. And you know the spot market isn't just the largest trading market in the world, it's also the market that trades the commodity we all know and love: money.
After all, we all use currency practically every single day in our lives. Yet few of us ever step into a corporate boardroom. So why is it that so many investors are more comfortable buying stocks than trading foreign currencies?
It doesn't make a whole lot of sense when you think about it. Especially considering we all live and work in a global marketplace. Half the items you see in the stores are made overseas. The oil and gas we use is mostly imported. The raw materials we use for building are even imported from overseas sometimes (and the U.S. also exports raw building materials to other nations).
Each of these international transactions implies currency exchange at some point along the way. It's only natural, then, to be able to trade the currencies themselves-even at the individual investor level.
That's what the spot market makes possible. You can start trading with just a few hundred dollars if you like. You can trade online. And it's a market that trades round the clock five days a week.
More importantly, you can trade according to your appetite for risk. You can target double-digit returns in interest and appreciation in a conservative manner, using little or no leverage (borrowed money). Or you can use moderate leverage of 10-to-1 and combine that with a strategy of trailing stops to protect your capital along the way. Or, if you have a real hankering for home-run-potential trades, you can take it just a bit farther.
You can try the kinds of strategies that are available only in the spot market, such as the "Option X" strategy.
Options That Pay Interest and Never Expire
Yesterday, we made the point that you can use leverage up to 100-to-1 in the spot market. That means you can control $100,000 of a currency with as little as $1,000 of your own money. We don't recommend using that much leverage because you can lose your capital quickly, as a 1% move would take out your entire $1,000.
However, if you're an aggressive trader, there are intelligent ways to use a little higher leverage than the usual 10-to-1 ratio many traders use in the spot market. We have devised one technique of trading with higher leverage we dubbed "Option X." Here's how it works...
Let's say you are very bearish on the US dollar. You want to score big if you're right and the US dollar tanks. If you're wrong, you're willing to lose just a maximum of, say, $3,500. That's your total risk. With an Option X Strategy, you could target $17,500 gains or more-even while limiting your risk to no more than $3,500.
In this example we're going to open seven separate trading accounts and we'll deposit just $500 into each one. Remember, in the spot market, minimums are very low so you can open an account with less than $1,000 without a problem.
Now, let's say we short the dollar in each of those accounts. And we short it against each of the seven other major currencies. So we go long the EUR/USD (which means shorting the dollar against the euor), we short the USD/JPY (shorting the dollar against the yen), and so on. We short the dollar against the Swissie, the Aussie, the kiwi, the pound and the CAD, as well.
You're going to place these trades using 50 to 1 leverage.
Now on some of these pairs, you'll have an interest credit to your account. That's because the currency you're long (such as the Aussie) may have a higher interest rate than the currency you're short (the US dollar in every case in this example). On other pairs, you'll have a net interest debit, however, because your long currency (such as the yen) will have a lower interest rate than the dollar.
For the sake of argument, we'll assume you hold these trades for a full year and your net interest cost on all comes out to an average of 2%.
At the same time, let's suppose your timing was spot on. And we'll say that the dollar lost an average of 12% against these currencies during that year. Your net gain then averaged 10% per position.
But, remember, you used 50 times leverage. So that means each $500 position controlled $25,000 worth of currency. So you're averaging 10% gains in each account on $25,000. That is, your profits are $2,500 per account. Multiply that by seven accounts and you have a total profit of $17,500.
You turned $3,500 into $21,000 while keeping your total risk to $3,500.
The Advantages of the Option X Strategy
You can get leverage with options, of course. But this is a superior strategy for a number of reasons. First, you have no expiration date on your trades. With a traditional option, by contrast, you pay a "time premium." The longer the term of the option, the higher that premium will be. There is no such premium in this kind of trade.
With traditional options, you also pay commissions and a fee per contract. No commissions here, only the spread. And that spread in these major currency pairs can be as low as 3/100ths of one percent.
In this example, you had a net interest cost. However, in other trades, it's quite possible you could receive a net interest credit. You'll never find a traditional option that pays you interest.
Finally, your risk was strictly limited to $500 per trade. If the dollar surprised everyone and soared in value against all currencies, the maximum you could have possibly lost was what you had in the account-not a penny more. And controlling risk is the first focus of successful traders.
This is just one example of the different strategies you can use in the spot market. And, don't forget, you can also trade simply for yield, appreciation or both, using little or no leverage-all with the objective of protecting your purchasing power in the event of a dollar crash. What you trade, when you trade and how little or how much leverage you use is entirely up to you.
Yet one thing is clear. The spot market is an enormous, liquid, versatile and extremely accessible market that offers opportunities to aggressive and conservative traders alike.