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How I Traded Currencies on the Internet
Low commissions, adequate spreads and plenty of market data. What else does a trader need?
By Ezra Zask
As a former currency trader, I occasionally feel that I have my finger on the pulse of the foreign exchange market. Over the past several months, I’ve been overwhelmed by the conviction that the yen would strengthen dramatically against the euro. The rationale: while the Japanese economy shows signs of life, Japanese interest rates have stabilized (indicating an inflow of funds into yen), and the European economies seem stuck with further interest rate cuts in the cards.
Unfortunately, with no trading room or expensive information systems at my disposal, I’ve had to restrict my trading to the futures markets. Recently, however, I found myself drawn to try out some of the Internet currency-trading sites geared to individual investors and small companies.
After a little research, I settled on Global Exchange Networks—one of the oldest and most comprehensive sites—because of the feeling it gave me of being back in an interbank dealing environment. In effect, the site serves as a miniature trading room. A price screen provides regularly updated prices for the U.S. dollar against the euro, Japanese yen, British pound and Swiss franc, as well as the cross rates between these currencies. For each currency, the screen provides a daily high and low as well as bid/ask prices, which are normally five basis points apart.
Another screen provides comprehensive news from ICP, a news service that extracts currency-related news from major sources such as Bloomberg and Reuters. The information is continuously updated and presented in an easy-to-read format. The site provides a number of useful trading tools, and a (free) downloadable technical analysis and charting program that’s adequate for most purposes.
If you don’t want to trade with real money, you can elect to establish an account in “demonstration mode,” which gives you a phantom nominal margin. This fully functional service provides access to all of the site’s information and tools, including the profit-and-loss reports that keep real-time positions and margins. The site also includes full-scale training help and a risk-disclosure document.
Actual trading takes place through an easy-to-use and relatively foolproof screen that calls for entry of the number of contracts (each contract equating to $100,000 of currency equivalent), along with instructions such as market or entry order, stop (loss) and limit (take profit) levels.
The firm’s income comes from its commission of $10 per round turn, which includes an insurance bond provided by MG Financial that covers clients’ margin accounts. Each trading contract of $100,000 currency equivalent is backed by only $500 margin provided by the client. This high leverage allows a trader to get into as much trouble as he could in any legal market in the world.
Here’s what happened:
May 1:
Comfortable in my new mock interbank trading room, I establish a demonstration account and begin putting my ideas into action. I place $100,000 of funny-money margin into the account, which allows me to trade the equivalent of $20 million.
The euro stands at 1.0579 against the dollar and the yen at 119.45. The euro/yen cross rate is quoted at 126.37. My forecast is that the yen will move toward 110, while the euro drops to parity, leaving a cross rate of 110, a gain of nearly 13 percent, or, at 200 leverage, a cool $2.6 million.
May 20:
Reality throws some obstacles in my way. Favorable economic news from Europe (especially Germany), combined with uncertainty about the Japanese government’s interest rate policies, cause the euro/yen cross rate to climb to more than 132. This 5 percent reversal on a $20 million position forces me to fork over an additional $1 million in margin to maintain my outstanding positions. I’m faced with the classic gambler’s dilemma. Even if I’m right in the long-term, I may not be able to stay in the game long enough to see the gain. Feeling confident with my Monopoly money, I ante up the additional $1 million and kept playing.
June 1–5:
The cross actually improves in my favor as the war in Kosovo and lowered interest rates hammer the euro, while continued stock market strength underpins the yen. The cross comes back to the starting point by June 5, allowing me to retrieve my badly needed $1 million margin. From here on, it will all be gravy.
June 11:
Things are looking especially good. Japan’s 1.9 percent rise in gross domestic product for the first quarter raises the yen to 117.63, leaving me with a mark-to-market profit of $1,300,000. (Time to check out the Ferrari?)
June 12–13:
The Bank of Japan’s intervention in the currency market catches me by surprise. Although it started earlier in the week, it increases in pace and ferocity as the bank seeks to weaken the yen. From its levels below 120, the yen weakens progressively and does not strengthen above 120. As a result, the cross rate remains anemic, closing on July 13 at 123.6.
The result? I close my shadow portfolio with a disappointing $400,000 gain. Not bad for a few hours stolen from other work, but hardly the millions everybody else seems to be making trading on the Internet.
I found that my on-line currency world compared favorably with my experience on a trading floor. For trading, mark-to-market portfolio-tracking, technical analysis, and timely news and interpretation, the Internet-based service is more than adequate for all but the most trigger-happy of day traders. The spreads tended to be a bit wider than true interbank rates. However, no individual gets true interbank rates anyway.
While I missed the bustle of the trading room, I think it would be far cheaper to purchase a Walkman and record trading room sounds than to reconstruct a dealing room’s information and portfolio technology from scratch. Given that Internet currency programs are only in their infancy, I predict that they will someday serve a significant portion of the foreign exchange trading conducted around the world.
Ezra Zask is a professional fund manager and financial consultant based in Lakeville, Conn. He can be reached at ezra.zask@snet.net.
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