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Good Day Currency Traders!

It was so much easier on the floor.

Back in the early 70's - around the time I was thinking more about baseball cards than girls - the father of financial futures, Leo Melamed, was kicking around an idea of his own.

He thought: Why couldn't you apply the same principles of futures contracts - the old standards that had served the cattle and pork markets so well for years - to financial instruments?

Turns out it was a pretty good idea. And it made a bunch of guys on West Jackson Blvd. a lot of dough.

So thus was born the International Monetary Market or IMM membership at the Mercantile Exchange. They started handing out shiny new green badges for anyone who wanted to step into a pit and try their hand at trading unheard of things like T-Bills, gold and...foreign currencies.


Back in a Much Simpler Time...
When No One Knew How to Trade Currencies

There was a time when you could have fit all the currency traders on the floor in a corner of the cattle pit. That was because back then, nobody knew how to trade currencies. Simple as the CME tried to make them.

Every contract represented a certain amount of the foreign currency based in dollars. So if you were bullish on the yen, you bought yen contracts. Simple, no?


But then a monster market called the foreign exchange or "Forex" reared its ugly head into public consciousness.

Suddenly, currencies were traded in pairs, like God - and Richard Nixon - intended them to be. Currencies were no longer prices that went up and down like livestock. Now the value of one currency was only worth something in terms of another currency. So now if you were bullish on the yen, well what do you do then?


My Ridiculously Simple Guide to Understanding Currency Pricing...

Well simply put, currencies are traded in pairs. That means the price of any currency is only relative to the price of another. But which is which?

The first currency in the pair is called the "base currency." It's always equal to "1" of that particular currency. (So one dollar, one euro etc.)

The second currency in the pair is called the "quote currency." It's how much of itself "1" of the base currency will buy you. This is the price you see on a quote screen - because otherwise everything would be quoted as "1" - and that would be dumb.

Say I'm looking at the U.S. dollar against the Swiss franc. I'd find a market that quoted me the USD/CHF ("CHF" = the "Swiss franc"). The quoted price would tell me how many francs I could get for my dollar.

So let's say the quoted price was .7500. Now this is where things get a little weird. That means for US$1 I could buy three quarters of a Swiss franc. Usually we don't think about buying things in fractional increments. ("I'd like half a beer please.") That's why some new currency investors get confused, at this point.

Let's say I check the prices again the next day and the USD/CHF pair now trades at 1.25 (that would be a big day in the markets). Suddenly, my US$1 will buy one and a quarter Swiss francs. That means I'm buying MORE of the other currency. When your dollar buys you more of anything, whether that's foreign currency, gold, hamburgers, beer, whatever - your dollar is getting stronger. And the flipside is true too.

If I check back the next day and I see a price of USD/CHF is .95. Then my dollar is buying less. It's getting weaker.

So the Moral of this Story is...

When you look at a currency chart - the strength or weakness of the base currency is displayed in regular terms. That is, when it's going up, it means the base currency is getting stronger. When the chart's going down, your base currency (the first currency listed in the pair) is getting weaker.

Check out the chart below...this shows your U.S. dollars in terms of Swiss francs.



The line is heading down - that's bad news for the dollar.

Now let's get tricky. You can also base currency pairs in something OTHER than the all-powerful dollar. Even something as paltry as that new kid on the block - the euro.

Let's see what the EUR/USD is doing. I check the price and get a quote of .85. That means that 1 euro will buy me roughly 7/8ths of a dollar. (Or in other words, around eighty-five cents.) CONVERSELY, for .85 cents I can buy 1 euro. Now that's better!

Now I go back to check the same quote again in a few years and see that the EUR/USD pair is trading at 1.50. Horrors! Now a little euro buys US$1.50. Much more than before. Or in other words, it costs me a buck and a half to buy a currency that didn't even exist 10 years ago.

So if I want look at a chart of this mess and determine what the dollar (the quote currency of the pair) is doing, everything is backward. As the dollar gets weaker, the chart goes higher. And vice versa. Like here...


The Euro Line Going Up is Bad News for the Buck



So, to recap:

Currencies trade in pairs


The first currency is the BASE and = 1


The second currency is the QUOTE and = what 1 of the BASE will buy


Strength or weakness - represented in the chart of a currency pair - shows what's happening to the BASE currency of the pair....
...and it was a lot easier trading currencies back on the floor at the CME in 1970.

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Making 'Cents' of the Headlines
What's Behind the Sage Pages of the Fed's "Beige Book"

From Currency Director: Sean Hyman

What's Happening:

In case you're not familiar with it, the Fed's "Beige Book" is really just a report that's published eight times a year. The Beige Book includes all the Fed's thoughts on the current economic conditions here in the United States.

What I Say:

Not surprisingly, the latest Beige Book just confirmed the problems that we've already been seeing. Tightening credit, more unemployment, slumping housing, higher food and energy costs, sluggish retail sales and the declining dollar were the main themes that were woven throughout the report.

The Fed's Mishkin summed it up when he said, "I continue to expect a period of economic weakness in the near term."

We'll be lucky if it's just the "near term," I say.

Until the "credit scare" is over with the banks, it won't end. This is hurting auto sales and the sale of "big ticket" items in the home.

"Tight fisted" credit, gigantic home inventories and falling prices will continue to elongate this "housing recession" which has already been the longest recession in a quarter of a century.

Many things have to happen before we'll see a turnaround. For instance, credit will have to normalize, food and energy prices will have to back off, houses will have to sell, employment will improve, etc. Then, and only then, will we know we're seeing a turnaround.

Until then, the ugly cycle continues onward.

With Bernanke asking banks to "forgive" some loans, that equals "banks taking some more losses." Saying they're "forgiving loans" makes it sound like a charitable act. However, in the end, the banks will be stuck holding the bag.

On the other hand, you could argue that banks deserve whatever they get. For years, they've basically wrote blank checks for housing loans. Bankers got sucked up into this decade's real estate bull market and completely lost sight of the risks involved. So now they're taking a few lashes as punishment. But as banks suffer, the public and business community will also suffer.

The economy can't improve until bankers feel they're "out of the woods." That's when banks will start handing out credit again, and firming up the economy. Unless this episode plays out differently from all of the rest, it will take quite a bit of time for all of that to work itself out. As it stands now, this could drag on for years...

So what do you do? Just hold your breath and wait? Absolutely not. There are still plenty of opportunities out there - even during a bear market.

Right now, there are plenty of decent "investment worthy" currencies like the Aussie dollar, New Zealand dollar, Japanese yen and Swiss franc. Plus, most commodities are sailing high (which helps the Aussie and Kiwi dollars too).

Out of that group of currencies, the Aussie dollar has the strongest fundamentals and the Swiss franc probably has the strongest defensive posture right now. And as always, the Japanese yen is a good long-term play against global market chaos.