The FX Trump Trade and other uses of Synthetic FX Pairs
One of the hottest topics right now is the ongoing US election and how it will affect the currency
markets. If we take Trump by his words, there’s no surprise two currencies should definitely be
affected strongly by a winning Trump, the Mexican Peso (MXN due to his plan to build a wall between
the US an Mexico) and the Russian Ruble (RUB as Trump wants to get closer to Russia).
Therefor the ultimate Trump-Trade is said to be RUB/MXN. Let’s check if that’s actually the case.
Here’s a chart of RUB/MXN daily closing prices (green line) and the daily election forecast for
Trump (blue line, data source http://cesrusc.org/) starting in September 2016.
Looking at the chart we can already see that there obviously is a correlation going on between the
election polls and RUB/MXN. Looking at the stats, I get a correlation coefficient of about 0.8
between the polls results and the RUB/MXN quote for this time period which is confirming our
observation. I didn’t really dive into the election poll data so I’m for example not sure at what
time of the day they’re actually available. So it could be I’d actually need to shift the election
data forward one day or half a day etc. But for the sake of this article which is to have a look at
synthetic FX pairs I guess it’s all fine.
Now if you’d like to trade this and want to go long RUB/MXN because you believe in the correlation
and think Trump will win you might run into an issue. RUB/MXN is probably not on your brokers list
of FX pairs. What to do, what to do?! Build your own!
Every forex cross pair is nothing else than buying an equal amount of it’s base currency and
selling it’s quote currency against the same currency (usually USD) if you want to go long the
cross, or doing the opposite if you want to go short.
Going long 100k units EUR/GBP for example is nothing else than buying 100k of EUR and selling 100k
of GBP against the USD. The opposite is true if you want to go short EUR/GBP, you sell 100k of
EUR/USD and buy 100k of GBPUSD.
Now for most retail traders this wouldn’t make much sense as the spread usually will be smaller
trading EUR/GBP directly which is available at every broker. This way you’ll also pay less
commissions and will of course need less margin since you put only one, not two trades on.
For institutions or traders who trade more complex FX portfolios things might look different, but
for most of us trading synthetic pairs makes no sense unless we have to.
One exception I’d like to mention is if you want to trade a cross with a different ratio. Why would
you want to do that? Because if you trade a cross with a different ratio of 1.2/1 for example you
get a slightly different price curve that for example might be more likely to show mean-reverting
behavior than trading it 1:1. You can go even further with this by including more than two
currencies. But that’s maybe a topic for another article, let’s go back to RUB/MXN!
So we want to trade RUB/MXN synthetically as our brokers doesn’t offer it as a cross. This means
trading USD/RUB and USD/MXN separately.
If we want to go long RUB/MXN we have to buy RUB and sell MXN against the same currency. So in this
case against the USD which means selling USD/RUB and buying USD/MXN. As we want this to be the same
as RUB/MXN, we go with a 1:1 ratio so we’d sell the same amount (100k for example) of USD/RUB and
buy the same amount of USD/MXN.
The opposite is true if we want to go short RUB/MXN, we have to sell RUB, so we buy USD/RUB. And we
want to buy MXN, so we sell USD/MXN.
That’s really all there is to it! Some might wonder if I have or plan to put any fundamental trades
on regarding the election. And the answer is no. I’ll just stick to trading my systems as usual.
All content on AlgoStrats.com is only for educational purposes to show you the type of systematic trades that you may consider once you have learned to trade and analyze the market yourself. It does not constitute investment advice. Marco Mayer & Trading Educators, Inc. will not accept liability for any loss or damage, including but not limited to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.
There is a substantial risk of loss in trading commodity futures, stocks, options and foreign exchange products. Past performance is not indicative of future results.
Trading Futures, Trading foreign exchange on margin and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures, foreign exchange and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures, foreign exchange, stocks or options on the same. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.
Any opinions, news, research, analyses, prices, or other information contained on this website, blog, twitter, youtube, facebook and elsewhere is provided as general market commentary for educational purposes only, and does not constitute investment advice. Marco Mayer and Trading Educators, Inc. will not accept liability for any loss or damage, including but not limited to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.
Derivative transactions, including Foreign Exchange Products and Futures, are complex and carry a high degree of risk. They are intended for sophisticated investors and are not suitable for everyone. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results, and all of which can adversely affect actual trading results.
CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL, OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE DISCUSSED WITHIN THIS SITE, SUPPORT AND TEXTS. OUR COURSE(S), PRODUCTS AND SERVICES SHOULD BE USED AS LEARNING AIDS ONLY AND SHOULD NOT BE USED TO INVEST REAL MONEY. IF YOU DECIDE TO INVEST REAL MONEY, ALL TRADING DECISIONS SHOULD BE YOUR OWN.