How to Choose a Forex Broker

Today, I'm going to take a break from covering the credit crisis in order to cover an important logistical topic: how should one go about choosing a forex broker? There are dozens (if not hundreds) of retail forex brokers, a fact which can be overwhelming to those considering dabbling in forex for the first time. The first step is to assess the quality of the broker, itself. Where is it registered? Those based in offshore tax havens should be treated with some degree of skepticism, as they are subject to lax, if any, regulation. It could be difficult to withdraw funds from an account held with such a broker. Along the same lines, what is the broker's reputation? Typically, the most "visible" brokers will also offer the best customer service, as much of their business is generated through word-of-mouth. Next, you should examine the product(s)? What kind of trading platform will you have access to? Will you have access to research and advanced (technical) analysis tools? What is the average execution time? The final considerations are financial. In other words, what is the spread and what are the terms of financial leverage. At the same time, you should be careful not to allow this latest aspect to weigh too strongly on your selection, reports The American Chronicle:
It's far too easy to be attracted to brokers that offer up to say 1:400 leverage, and therefore allow you to take out very large positions with a small margin, but this is a very dangerous game and it's all too easy to over-leverage yourself and wipe out your account completely.

All Signs Point to Down

Regardless of your preference, all economic indicators seem to be heading in the same direction: down. Home sales and home starts, as well as home prices, are way down and projected to fall further. Consumer spending is declining by double-digits (in annualized percentage terms), which is no surprise considering consumer sentiment recently touched an all-time low. The national unemployment rate and unemployment insurance claims are rising nearly every month and week, respectively. Factory production is falling, and inventories are rising. Stock market capitalization is down across the world, especially in export-driven markets like Japan and Korea. The US economy as a whole contracted in the last quarter. The distinct lack of nuance in the economic picture has led most economists to project that the current recession (although not officially a recession) will be the worst in decades. The Wall Street Journal reports:
The current downturn is shaping up to be worse than the recessions of 1990-91 and 2001 and the prolonged downturn that ended in 1982. Banks are cutting back on lending, consumers are spending less, companies are shedding jobs amid sinking profits, and the housing bust that triggered the slide persists.

Forex Liquidity and the Credit Crisis

Most of the commentary surrounding the dual Dollar-Yen rally that has unfolded over the last couple months has focused around monetary policy and risk aversion. Accordingly, the prevailing theory is that both currencies are being driven upwards because of narrowing interest rate differentials and a collapse in risk tolerance. However, it's also important to consider the role of technical/financial factors. Specifically, liquidity in forex markets is dissipating rapidly as market participants have found it difficult to secure lines of credit to finance leveraged currency trades. In addition, those with leveraged short positions in the Dollar and Yen have been forced to partially unwind their positions for the same reason. In hindsight, the decline in both the Dollar and the Yen over the last few years now appears to have been driven primarily by the same expansion in credit that underlied the real estate bubble, which enabled traders to take advantage of interest rate differentials to earn relatively risk-free profits from a carry trade strategy. Regardless of the fact that these interest rate differentials persist and a carry trade strategy remains theoretically viable, it's becoming impossible to undertake because of a shortage of credit and liquidity. FX Solutions reports:
The credit crash has affected participation rates in all markets. Many speculative players who depended on credit and leverage to fuel their trading have withdrawn. They will not return anytime soon. In the currency markets this permanent drop in liquidity may keep price movement volatile long after calm has returned to other markets. It has substantially diminished liquidity in the yen crosses which were, for so long, the speculative favorites of currency traders.

Forex Intervention: Back on the Table?

With the Dollar rallying to multi-year highs and the Yen surging to multi-decade highs, some analysts have begun to re-assess the possibility of Central Banks intervening in forex markets. As if on cue, leaders from the G8 countries also released a statement expressing their concern. It is not a stretch to say the last few weeks have been awash with stories about emerging market economies that have been destabilized as a result of the rapid depreciation of their currencies, as well as companies that were forced into bankruptcy as a result of currency speculation gone bad. Meanwhile, the US and Japan are certainly nervous about the impact of more expensive currencies on their respective export sectors. Ironically, it was only six months ago that some analysts were gaging the same probability of intervention; at that time, however, the purpose would have been to prop up the Dollar, whereas now it would be to bring it back down to earth. I suppose the moral of the story is that in forex terms, six months is practically an eternity. Besides, as we reported yesterday, both the Dollar and the Yen have already begun to fade. The Wall Street Journal reports:
"But, this is not a currency crisis" said a foreign exchange strategist. "This is a liquidity crisis, a growth crisis, a confidence crisis. As such, probably the first step should not be to intervene to save currencies."

Forex Rally Comes to an End

These days, the Dollar and the Yen are veritable proxies for investor confidence/risk tolerance. As a result, on days when US stocks rise, the Dollar (somewhat ironically) will typically experience a decline. Over the last couple weeks, it should therefore come as no surprise that the tremendous rise in US stock prices was matched by a proportional fall in both the Dollar and the Yen. If only for technical reasons (i.e. that the scale tipped too much in the other direction), it seems investors have regained some of their comfort with investing in emerging markets, leading some of the hardest-hit currencies (Korean Won, Brazilian Real, Mexican Peso) to recover some of their gains. Call it wishful thinking, but some investors now believe that the US recession will be milder than originally forecast, which would certainly exert a positive impact on such emerging market economies. In addition, there were monetary factors underlying the currency reversal, reports The Washington Post:
There were more specific reasons for some of the fluctuations. A news report that the Bank of Japan might cut rates in the near future was a factor in driving down the yen.

Hedge Funds Crush British Pound

The British Pound is perhaps one of the worst victims of the credit crunch, having fallen 25% against the USD in the year-to-date. According to analysts, hedge funds deserve much of the blame. Apparently, most hedge funds, including those that are based in the UK, denominate their portfolios in terms of Dollars. As a result of the exodus away from emerging markets, such funds have found themselves awash in cash, which they have promptly converted into Dollars. The reasoning behind this investment strategy is twofold: first, as the incredible strength of the Dollar has illustrated, the prevailing wisdom among investors is that the US is currently the least risky place to invest. Second, the interest rate gap between the US and the rest of the world looks set to narrow, which means the yields on US security will become relatively attractive. The Telegraph reports:
Worldwide interest rate forecasts are being revised downward, which has increased interest in the US where rates have already been slashed.

Forex Volatility Destabilizes Global Economy

Volatility in forex markets has surged to unprecedented levels. In the words of one analyst, "Moves in the currency markets witnessed during just a few hours of trading...'are typically what we see in a quarter.' " The currencies of both emerging market countries and industrialized nations have been battered indiscriminately, as investors have fled to locations perceived as less risky, namely the US and Japan. On the one hand, a stronger Dollar has almost completely alleviated inflation in the US and will hence make it easier for the Fed to continue cutting interest rates. On the other hand, US exports, previously one of the few bright spots in the sagging economy, will become less competitive. Then there is deflation, long since relegated to history textbooks, but now once again considered a threat. Countries whose currencies have declined, meanwhile, are finding it difficult to convince investors to stay put, and have taken to deploying their forex reserves as a stopgap measure to stabilize their respective economies. The Wall Street Journal reports:
To combat these sharp moves, Brazil, Mexico, Russia, and India collectively have drawn down their reserves by more than $75 billion since the end of September, selling dollars to protect their currencies, according to Win Thin of Brown Brothers Harriman.