By Evaldo Albuquerque, Editor, Exotic FX Alert
I want to let you in on a secret.
It’s something all the best professional traders know, but few “little guys” take advantage of in the markets.
But if you’re one of these elite few, you can grab some significant profits on every market crisis, every black swan event, every time the markets go a little haywire… on days like yesterday when the Dow fell over 400 points before lunch.
It’s the secret to crisis currency investing, and it’s worked through all the major market upheavals for the last 15 years.
Let me show you how it’s done…
Asian Financial Crisis =
Opportunities in Currencies
In July of 1997, the world saw the beginning of what would become a famous financial contagion, the Asian financial crisis.
It started in Thailand, where a sudden crisis of confidence caused the collapse of the local currency, the Thai baht.
At the time, several Thai companies were holding massive amounts of debt denominated in foreign currency. So when the local currency lost half its value, those debts basically doubled in a very short amount of time.
Default was the only way out for Thailand. Then came a massive wave of bankruptcies and layoffs.
One month later the same thing happened in Indonesia.
And that was just the beginning. By October, the crisis had spread to Hong Kong, South Korea, Malaysia, Laos and the Philippines.
The effects of the crisis lingered for a couple of years. In the Philippines, for example, growth dropped to virtually zero in 1998.
But while Asia suffered, currency traders cleaned up. Let me show you how.
Exotic Currencies Act the
Same in Times of Crisis
The Asian crisis is just one example of an economic downturn in emerging markets.
In the 90s we also had the Mexican peso crisis, where the Mexican peso devalued overnight. Then we watched as Russia defaulted.
All these crises have something in common: as the emerging market economy sunk into crisis, the local currency collapsed.
The Korean won, for example, fell from 886 won per dollar to 1701 won per dollar in about six months. The Mexican peso crashed from 4 pesos to the dollar to 7.2 to the dollar in the space of a week.
Fast forward to 2008, and we saw that emerging market currencies react the same way, even though the crisis started in the U.S.
We all know that emerging markets had very little to do with the 2008 financial crisis. And yet, emerging market currencies got crushed when the stock market crashed.
It’s easy to see why.
When market sentiment is good, investors want to shoot for higher gains. They are willing to take chances and invest in a bit more exotic markets. So investment capital flows to emerging markets when stocks are rallying overall.
But when there’s a major risk event, investors do not hesitate to pull their money out of those countries to invest in something safer.
Since U.S. stocks peaked last month, for example, emerging market currencies have been taking a dive. The Turkish lira has fallen 9.4%, the South African rand 7.2%, and the Hungarian forint 4.3%.
The Mexican peso provides another example. The U.S. stock market has crashed in the past few weeks because of fears the U.S. economy is heading into another recession. Like other emerging market currencies, the peso has also plunged in recent days.
The Mexican Peso Crashed Along With U.S. Stocks
An Ideal Shorting Opportunity
As a currency trader, it’s just as easy to short a currency as it is to buy it.
Over the past couple years, these smaller exotic currencies from emerging markets have become easier to trade than ever before. Liquidity is higher in these pairs, so more Forex brokers are offering them as trading possibilities.
That means when a crisis hits the markets, it’s easier than ever to short them. Specifically, shorting them against the U.S. dollar.
Although the U.S. is in terrible financial shape right now, currency traders still consider U.S. dollar as the place to hide in times of crisis. (Yes, even after the recent downgrade.)
That’s why the dollar rallied during the 2008 crisis… why the dollar tends to rally when more sovereign debt news comes out of Europe… and why the dollar jumped against the European exotic currencies over the past couple days.
Going forward, it’s highly unlikely that stocks will make a dramatic recovery. As the European debt crisis spreads to the U.S. markets, and even booming nations like China and Australia slow down, emerging markets will suffer.
A simple way to profit is to short these emerging market currencies against the dollar. And using the standard 20:1 leverage, it’s easy to maximize your profits in times of crisis. You can use those short-term gains to offset some of the losses in your equity portfolio.
Bottom line: stocks still have farther to fall, and crisis reigns in this market. But simply shorting a few currencies can help protect the rest of your portfolio along the way.
Editor, Exotic FX Alert