For those who trade foreign futures...

[LeviF]

I don't know much about foreign futures, but I assume they are priced in their home currency. Do you consider exchange rate fluctuations when making trading decisions? For example, pick a foreign future like Tokyo rubber (i think i've heard of that one), say rubber breaks out. You take your currency (USD for example), exchange it for yen, and buy rubber. However, what if rubber really isn't going up, but yen is going down? Rubber goes through the roof on the charts (yen plummets) you sell, exchange your yen for USD, but now you're back to the same place you started?...

[sluggo]

On September 1st, you and I make a bet about the weather in Japan. We agree that whoever loses the bet will pay the winner (20,000 Japanese Yen) two months later, on November 1st.

Between September 1st and November 1st, the USD/JPY exchange rate fluctuates wildly.

Then November 1st arrives and the loser pays the winner (JPY 20,000).

Question 1: Is there any possible scenario of exchange rate fluctuations, that would cause the "winner" to actually lose money on the bet?

Question 2: Translate this story into an easily remembered, one sentence aphorism about trading futures contracts that are denominated in other currencies.

[AFJ Garner]

Do you consider exchange rate fluctuations when making trading decisions?

You make a very good point indeed and one which I have pondered endlessly when looking at ETFs.

Ideally, your system or your price series should take account both of the asset price and of the exchange rate fluctuations when issuing buy/sell signals. Let me give you one easy example where the price series does just this for you.

Take the US listed iShares for Spain, Portugal, Germany, France etc etc. They are denominated and trade in US dollars and yet the underlying assets are in Euro. Assuming that the arbitragers do their job, this is very convenient for US investors – you will only get a signal if the deal makes sense both as regards the local stock market performance and the currency. Your profits and signals on such markets will be muted if the Euro is tanking.

If a US investor wants to trade a non USD investment not quoted or traded in USD, he might consider creating a USD price series from the local price series and see how this would affect his signals and his P&L.

[sluggo]

The timing of the currency conversion is worth remembering.

Some transactions (taking a position in a stock or a mutual fund or an ETF) perform the conversion upon entry.

Other transactions (taking a futures position) perform the conversion upon exit.

[AFJ Garner]

The timing of the currency conversion is worth remembering.

Other transactions (taking a futures position) perform the conversion upon exit.

Except of course for the initial margin.

[LeviF]

The RUBBER/JPY position is equivalent to RUBBER/USD * USD/JPY, so USD movement is of minimal consequence?

[svquant]

An interesting experiment that some might find enlightening would be to trade the same (or similar) contract in two different currencies and see how the same system performs on each. There was an academic paper quite a while back on this (don't have the reference off hand). Basically looked at coca in NY (USD) and London (GBP) and found that the systems examined (moving average) gave different results only due to the trend in the GBP during the time period examined.

While not exactly this subject - thought it would be good info and perhaps get someone to crank up TBB.

Also while I think we have the info embedded in the answers above in general one can only turn a profitable trade into a loss if the loss on the exchange rates used for the margin is larger than the profit of the actual trade. Same is true on the converse - a loosing trade can only be made profitable if the gains on the margin due to exchange rate fluctuations is larger than the position loss.

[Asamat]

I have two thoughts to add:

Do you consider exchange rate fluctuations when making trading decisions?

a) It depends on the idea behind a trading method. The idea behind a price breakout

... say rubber breaks out. ...

is you want to see a price movement of the instrument so strong, that you may take it as an indication that something significant has changed. If the breakout in USD was simply because the rate changed, but no movement of the instrument happened, this is not what you are looking for. So for channel breakouts I would argue to look at prices in the local currency. For other trading ideas this might be different.

b) In case of a long term system (many months to years) the exchange rate might have an influence on the instrument, which you might want to take into account in the decision. This borders on fundamental analysis. The effects are clearly there, however, difficult to take into account with mechanical systems.

For example, in case of a stock index like the DAX, the German companies behind the index will do better if their currency is not strong, implying the DAX itself will probably gain from a falling EUR, or get hurt by a further rise (against other currencies as well, but mainly against the USD). Second example, interest rate instruments are (long term) correlated to exchange rate changes, since the latter are - at least according to theory - caused by interest rate differences. Both depend on whether the local economy is doing well or not.

This effect b) would be additional to the direct effect of the rate on the trade result. It might amplify or dampen the results direct rate dependency. In the latter case you have something like a natural hedge.

Regards,
Asamat

[cryder]

This scenario was a discussion point in a news letter I receive:

<But how these exchange rate movements can affect the outcome of a trade is best illustrated with an example. Jane is located in Australia and purchases 1,000 IBM shares (New York Stock Exchange) on the 14th February 2003 at US$77.10 per share, she closes this trade on the 27th June 2008 at US$123.00 per share. In the time that Jane had her $US trade open, the US Dollar depreciated in value against the Australian dollar from 1.6949 to 1.0493.

Purchase = 1000 * 77.10 = USD$77100.00 ( *1.6949 = AUD$130,676.79)

Sale = 1000*123.00 = USD$123,000.00 (*1.0493 = AUD$129,063.90)


USD$ P/L = 123,000.00 – 77,100.00 = 45,900.00
AUD$ P/L = 129,063.90 - 130,676.79 = -1612.89>

Regards

[LeviF]

I guess this is why it is important to price the instruments in your home currency. IBM/AUD was essentially flat after 5 yrs, while IBM/USD did well.

Afterthought: this seems to be more important in non-margined instruments. If you are borrowing the home currency then its not as important.

[sunyata]

If a US investor wants to trade a non USD investment not quoted or traded in USD, he might consider creating a USD price series from the local price series and see how this would affect his signals and his P&L.

AFJ,

Do you happen to know if Trading Blox performs a similar conversion on the data prior to a backtest? And if not, how does it account for trading in non-dollar-denominated markets?

Merci!

[AFJ Garner]

No, TB does not do this. TB does however take into account both the price change of the non base currency instrument and the change in the relevant FX rate when calculating the P&L on a trade.

[sunyata]

No, TB does not do this. TB does however take into account both the price change of the non base currency instrument and the change in the relevant FX rate when calculating the P&L on a trade.

And I suppose it accesses the exchange rate for the particular day of the P&L calculation?

Thanks for your help. I am building a simulation engine in C# and want to take in account as many realistic aspects as possible.