In our previous article on robo-advisors we took a look at the basics of what a robo-advisor is. This included some of the most common functions that these advisors perform, and the basic costs associated with them. Here we will dive a little deeper on the services they offer and how it all actually works. We will also take a closer look at some of the advantages you can derive from using a robo-advisor no matter if you are brand new to trading forex and the markets, or you are a more experienced trader.
What Can a Robo-Advisor Do?
Robo-advisors and their use is becoming increasingly popular for investors who want to build a portfolio which is instantly adaptable in the fast-paced forex market and trading in other markets around the world. This adaptability comes from the fact that a robo-advisor is actually an automated software which is programmed with algorithms which enable it to take specified actions under certain market, or other pre-determined situations.
Basically, these algorithms can ensure that your portfolio always stays in line with risk parameters and other conditions you set out when you sign up for a robo-advisor service. This is done through what the brokers refer to as portfolio rebalancing. In essence, your investment portfolio should always be operating at optimum levels when you are dealing with a robo advisor.
Although portfolio rebalancing is the core service which many robo-advisors focus on, if you are an experienced investor, there are also some other services typically made available which you can also take advantage of. These include the robo-advisors ability to sell assets at a loss in order to offset certain gains, and therefore reduce your tax liability. This is known as tax-loss harvesting and it can be beneficial depending on your situation.
Who Are Robo-Advisors Aimed At?
Now that you know how a robo-advisor functions, you may wonder what types of trader the software and services are aimed at. The answer here is broad. There are many types of trader who could benefit from the services of a robo-advisor. These include the following:
New Investors: If you are new to trading in any market, the learning curve can be steep. It can take time to accumulate enough knowledge where you feel you can trade freely and make your own independent trading decisions. In the meantime, a robo-advisor can be an ideal solution helping to enact a trading strategy broadly set out by you within simply defined parameters.
Busy Professionals: You may be a very experienced investor but simply lack the time to dedicate to managing your portfolio on a regular basis. A robo-advisor can be an ideal choice which can effectively save you any time but essentially putting you portfolio into auto-pilot but in a professional manner, backed by a proven service.
Traders Requiring Assistance: Many of us, whether new, or experienced in trading, could do with a helping hand. This comes at a high cost if you are consulting with financial advisors to offer advice and execute trades. Although most robo-advisors will not offer any financial planning service, they will take care of executing trades according to the pre-defined strategy selected.
These are just a few categories of traders who may find a robo-advisor to be useful. There are many more situations where the use of a robo-advisor could prove beneficial depending on the complexity of your investment portfolio.
Cost is always a key consideration when it comes to any kind of financial service. This is typically where a robo-advisor can emerge ahead of many more traditional options. Typically a robo-advisor will charge between 0.25% – 0.5% of the value of assets in your portfolio, for example, if your total portfolio value was $10,000, a 0.5% fee would equate to just $50 a year. This is most common method, though some may also charge a monthly flat rate fee. Such fees can start from $10 per month and increase depending on your portfolio value.
Generally, this means that the cost of employing a robo-advisor is much lower than that of seeking an in-person financial advisor, or dealing with a full-service broker. With many robo-advisors you can also benefit from a free trial period which you can use to evaluate the service. There may also be transaction fees related to the trades made in rebalancing your portfolio, though these are waived in many cases. This again will be based on the value of your portfolio.
The Benefits of Using a Robo-Advisor
There are many benefits to using a robo-advisor which have hastened the adoption of such services by traders. Here are a few of the most common.
Time Saving: With the robo-advisor service being fully automated, you can undoubtedly save time. Not only is this referring to your own personal time and effort in managing your portfolio, but also making sure that your trades are executed in as small a window as possible. This improved efficiency can mean you lock in the best possible prices when entering and exiting positions.
Lower Cost: As we mentioned above, the cost of engaging the services of a robo-advisor is much lower than going down the traditional route. Not only the service and transaction costs, but also the minimum deposits needed to use the services are generally much lower. This makes a robo-advisor much more accessible to traders.
Reduce Errors: Nobody is perfect, although since a robo-advisor is based solely on programmed software, it is virtually impossible to deviate from the plan. This can assist you at every level as a trader, if you are new and getting to know the industry, or if you are more experienced and perhaps relying on the judgment and recommendation of a financial advisor.
Overall, robo-advisors work in a way which is both cost-effective, and timely to manage your portfolio through a very consistent set of algorithms which allow you to set parameters and effectively take a back seat. This has proven to be very popular throughout the industry as more and more people get involved in all forms of trading, and look for the most efficient solutions possible when it comes to portfolio management.
What are Carry Trades in Forex?
As you continue increasing your knowledge about forex trading and the market in general, more and more new concepts and ideas will pop up. This includes a growing range of trading technique and strategies. One such trading strategy which has been around for a very long time in the industry, is the carry trade. Here we will take a closer look at exactly what a carry is in forex, and provide all the information you need to decide if carry trading is a good strategy for you as you move forward on your trading journey.
The Basics of How a Carry Trade Works
In its most simple form, a carry trade in forex, is borrowing one currency, and using it to buy another. For example, you may borrow (sell) $100,000 Australian Dollars, and use those funds to purchase the same amount of JPY. Placing a carry trade is one of the most popular trading strategies in the entire sector, and used by many traders to benefit from the position of currencies around the world.
So, what is the benefit in borrowing one currency and using it to buy another? This comes from the difference in interest rates between the two currencies. Let’s look again at our example in more detail.
Presuming the interest rate on the Australian Dollar was 4%, and the interest rate on the JPY was 0.1%, a carry trade would be where you buy the AUD/JPY market, as here, what you are effectively doing is selling (borrowing) Japanese Yen, to purchase Australian Dollars. In the most simple of ways, you will now have placed a carry trade. Here you will earn 4% interest on the Australian Dollars you are holding, while paying 0.1% interest on the Japanese Yen you have borrowed. This should leave you in a profitable position if the rate does not change, and is known as a positive carry trade at +3.9%.
Why is Carry Trading in Forex So Popular?
From an outside perspective, even looking at our hypothetical example where there is quite a gap between the interest rates, you may wonder why placing carry trades is so popular when the potential profit may seem quite small. There are two main elements at play in the forex market though which make this a very attractive type of trading strategy.
Currency Pairs: The fact that currencies are traded in pairs make a carry trade very accessible, and convenient for all traders. The difference in interest rates has never been so easy to take advantage of as it is in forex trading, where you can directly trade low and high interest currencies in pairs.
Leverage: The availability of extensive leverage in forex makes it the ideal place to carry trade. Many forex brokers can make leverage of up to 500:1 available on certain currency pairs. This basically means that even a relatively small deposit of $1,000 can open up huge buying power of $100,000 at 100:1 leverage, or more. Dealing with such large numbers, even low percentage profits are very meaningful.
Popular Forex Pairs to Carry Trade
Given the fundamentals of how a carry trade works, borrowing a low interest currency, to buy a high interest currency, then this is precisely what traders are on the lookout for in the forex market when it comes to placing a carry trade. There are a couple of currencies in particular that are most popular in this regard.
As a selling currency, the Japanese Yen is always a very popular choice. This is thanks to the historically very low cost of borrowing in Japan. The country has not had an interest rate of above 0.5% in more than 20-years. Another popular choice as a selling currency may be the Swiss Franc (CHF).
On the buying side, popular choices include both the Australian, and New Zealand Dollar as countries which typically hold slightly higher interest rates, yet are recognized as quite stable currencies.
Benefits of a Carry Trade
A carry trade in forex can be an excellent long-term investment strategy. You will have the potential to benefit from a carry trade even if the rates do not change at all thanks to the difference in interest rates. This makes it perfect for an investor who intends to hold the position for a long time.
Added to that, if the rate does change in your favor, then you can potentially have a sizable profit when added to the interest rate difference, and factoring in the leverage used. The fact that many brokers nowadays also cater for trading with very competitive fees and low spreads also plays to your advantage if placing a carry trade, and is something that many look out for.
Risks Involved in a Carry Trade
With every form of trading, there is always a certain element of risk. With a carry trade, though it is seen as a low-risk strategy, there are still a couple of things to be mindful of.
The market can still move against you. A change in the market can certainly negate any benefits you have gained from the positive interest rate difference. Particularly if you decide to trade in minor, or exotic currency pairs which are less common, you should note that these markets can be highly volatile, and subject to change in a very swift fashion. Some examples include trading with the MXN (Mexican Peso), or NGN (Nigerian Naira). Both may appear attractive for a carry trade, but can be subject to intense volatility. This risk can be amplified even further if you are trading with a lot of leverage.
You should also remember that, just because there may be a positive rate difference at the moment, the monetary policy in every country is subject to change at different times. The perfect example of this would be right now, in the midst of the coronavirus pandemic, many nations have moved to cut interest rates. This has the possibility to really change the dynamics of your carry trade.
What Are Currency Swaps?
As you gain experience trading the forex market, you will come across an increasing number of terms. One such term is a currency swap. These kind of transactions actually make up for a large amount of the volume traded on the markets, and they are commonly applied in a few situations when you are trading forex. Here we will explain in more detail exactly what currency swaps are, how they usually occur, and why they can be beneficial to certain types of traders in the sector.
The Basics of a Currency Swap
In the most simple of terms, a currency swap does exactly as the name implies. It is an exchange of currency between two parties of the equivalent amount of money in another currency. There is then a contract in place to repay this money at a specified date, and exchange rate in the future. In essence, this is a currency swap. A currency swap can bear some similarity to that of currency futures, though they differ in the sense that they are held until settlement, and considered to be a large part of forex trading, whereas currency futures are traded on other exchanges.
Currency Swap Example:
Party A, and Party B enter an agreement to swap €1,000,000 for $1,150,000. This fills the need for the counter currency for both parties, and creates an implied EUR/USD exchange rate of $1.15.
The transaction is then completed at a future defined date, using either the original exchange rate of $1.15, or another agreed upon exchange rate. Essentially, the two parties are loaning a particular foreign currency to each other. In some cases with currency swaps, this can include the payment of interest or principal amounts on loans, though this will depend on the details of the individual agreement.
Who Typically Engages in Currency Swaps?
Currency swaps used to be the preserve of those in countries where the foreign exchange rates were extremely volatile, or as where they could be used as a mechanism to overcome currency restrictions.
While this is still the case on a more limited basis, the use of currency swaps has increased around the world as investors and companies become increasingly multinational. Here are a couple of examples of where currency swaps are most often used to good impact in today’s forex market.
Companies Doing Business Abroad: Currency swaps may be particularly beneficial to businesses who have interests abroad and need to borrow in order to conduct this business. They may not necessarily benefit from favorable loan terms from banks outside their home country. Therefore, if they can borrow money in their home country at the best terms, and conduct a currency swap with a similar company in the country they are seeking to invest, then this trade could be of benefit to all involved.
Volatile Currencies: A currency swap may be beneficial, an almost essential in some cases, for institutional and retail investors in nations where the local currency is known to be volatile. This is one of the main purposes behind engaging in a currency swap, to guard against currency risk with more volatile currencies. By engaging in a currency swap, both parties can set the terms, and have a certainty around the cost of their trade.
As we can see with these examples, currency swaps are most often used by companies, and other types of institutional investors. This is certainly a more common situation than the use of currency swaps by retail investors, although in some situations, retail forex traders can be impacted.
Risks Involved in Currency Swaps
While currency swaps can be beneficial in the most part for the points noted above, just like any form of trading, they are not completely without risk. If you are engaging in a currency swap, here are a couple of the primary risks you can expect to encounter.
Interest Rate Fluctuation: One of the main purposes of engaging in a currency swap may be to take advantage of better interest rates in the currency that you are borrowing as part of the deal. These interest rates though are often left floating in contracts. Therefore, there is a chance that a change in the exchange rate could negate any of the cost-saving benefits you hoped to derive from the currency swap in the first instance.
Exchange Rates: With currency swaps, perhaps the most important element is the exchange rate. This is often pre-defined within the swap contract to be a set rate at the future time when the deal reaches maturity. Here again, there is a chance that the future rate is worse for one party than the original or current rate. In this case, there may be a slight loss on the swap.
Forex Trading Swap Fees
The term swap fee, or forex swap is something you will also encounter if you are an online forex trader. This can also be known as the overnight fee, or rollover fee, and may sometimes be confused with the currency swap.
This is a “fee”, though it can be either positive, or negative, that is applied to positions you hold open overnight when trading through your forex broker. This amount is constantly changing, and basically represents the difference in interest rates on the currency pair which you are holding. Therefore, holding a long position in certain currency pairs will see you credited with the positive interest difference, while short positions will see this fee deducted from your balance.
Although it is typically an area of more concern for more experienced, and institutional traders, the currency swap still plays a huge role in forex trading overall, and is a very useful trade to be aware of. This is particularly true if you are looking for one of the most secure ways to deal in a large amount of foreign currency and in a situation where you wish to add some degree of security or control to the trade over a long period of time.
What are Currency Futures?
If you are trading in the forex market, you likely know that is the largest trading market in the world based on volume. Did you know though, that there is not only this market in which you can trade currency?
That’s right, you can also trade in the currency futures market. While not as large in terms of volume, it still provides you access to trade forex, just from a slightly different angle. Here we will explain all about the currency futures market, how you can get involved, and what type of assets you can trade here.
An Introduction to Currency Futures
The first question you may be asking is, what exactly are currency futures? In order to know this, you first need to understand what futures trading is. Futures are basically contracts that are exchange traded. Within these futures contracts, you agree to purchase an underlying asset at a certain point in the future, for a set price. Your hope when trading futures would be that the asset you agree to purchase in the future would have an improved price to that in the contract which you purchased.
Currency futures are futures contracts traded where the underlying asset is the exchange rate of that currency. For example, you may purchase a EUR/USD future contract on the exchange. This means that at a set point in the future (if you let the contract expire), then you will receive $125,000 in Euro. Depending on the exchange rate at that future time vs what you had purchased the contract for, you may make a profit by allowing the contract to expire, and taking delivery of the $125,000 worth of Euro. In most cases though, the futures contracts are regularly re-traded around the market.
Where Can You Trade Currency Futures?
Many major forex brokers will offer trading in both spot forex (What we typically think of when we discuss forex trading), and currency futures. You will also find that futures are offered with almost all full-service brokers.
When it comes to the markets you are trading on though, this is when the major difference kicks in. Trading spot forex, is done through your broker on the decentralized forex market. Trading in currency futures is done through exchanges. The largest of these exchanges, and the place where currency futures were first introduced for trading in 1972, is the CME (Chicago Mercantile Exchange). Trading is offered on various other exchanges around the world as with most other futures markets.
The Benefits of Using a Robo-Advisor
There are many benefits to using a robo-advisor which have hastened the adoption of such services by traders. Here are a few of the most common.
The People Who Usually Trade Currency Futures
Anyone can start to trade in either the forex market, or the currency futures market so long as you have access. With that said, the futures markets in general are typically popular markets for many day traders. This also applies to the currency futures market.
In the example mentioned above, we look at what happens when your currency futures contract expires and you essentially take delivery of the currency you have bought in the contract. The reality though, is that this expiration rarely happens to traders. Instead, the contacts are re-traded on the exchanges as rates change and there is speculation on a daily basis. An example of such a rare case where many futures contracts expired could be seen in recent months when the price of oil futures went negative. This will have left many traders with expired contracts, having to take delivery of huge oil shipments, or trying to offload the contracts before expiry which led to the negative pricing.
Because of the trading nature of currency futures, you will also likely need access to a little more equity when it comes to startup costs than you would do if you were trading spot currency on the forex market.
The Differences Between Trading Forex and Currency Futures
There are several key differences you should be aware of when it comes to trading on the forex currency market, and trading in currency futures. Here are a few of the major ones:
The Rate: The rate you will typically have when you are trading forex in the usual way if the spot rate. That is the rate that the currency is valued at right now. When trading currency futures though, this rate will be the forward rate. The forward rate is typically different as it tries to factor in the price at a future date based on the futures contract. Therefore, you will notice that if the spot rate goes down, the forward rate usually will too, and vice versa.
Leverage: When trading forex, you will typically have access to very high leverage. This could be up to 500 times your balance depending on your location. This is not the case with currency futures trading where leverage tends to be much lower, and the equity requirement higher.
Commission: The fees and commissions that you have to pay if you are trading futures are typically quite a bit higher than those you may encounter trading forex. In fact, many forex brokers allow for commission-free trading. With futures trading though, there will be a commission involved.
Margin: Since currency future contracts are of a set value, usually around $125,000 per contract, then it is typical for them to be traded on margin. This means having a deposit of $2,500 or more depending on the contract, and borrowing the rest from the broker. If the contract did expire, then you would have to honor the contract payment amount, whereas with forex trading, many brokers will automatically close positions if your account equity is becoming negative.
If you are interested in trading currency, then the currency futures market offers another excellent alternative for you to think about beyond trading in the forex market. Generally, trading in the futures market of any assets tends to be a little riskier, and in the case of currency futures, you will need a bit more capital to get started. With some experience though, particularly if you are interested in day trading, currency futures could be a good choice.