Speculators

As noted previously, there are a wide variety of currency speculators and therefore it is no easy task to explain their methods or techniques since they too vary widely. The techniques of currency speculation vary widely, just as with stock market speculation. Indeed, the analogy is a good one. Just as in equity investment where you have “top down”, “bottom up”, “value investing”, “growth or income” investing, so in currency markets you have speculators or investors — however one likes to term them — who focus on the macroeconomic “big picture”, long-term currency valuation, microeconomic factors affecting currencies, money flow and technical analysis. The titles are perhaps different but the guiding principle is the same; what separates and differentiates the framework within which they analyse the market. Below, we attempt to summarize the types of techniques and strategies with which currency speculators approach the currency markets.

The obvious answer is of course simply to make money. At a slightly more sophisticated level, market participants undertake currency speculation for the reason that they think they can earn excess returns by doing so. In turn, the reason they think that is because they or others have done so in the past.
Just as fashions and retail trends change over time, so does the idea of “conventional wisdom” within financial markets. In the 1970s, despite the break-up of the Bretton Woods financial system, the conventional wisdom was to have pegged currency regimes and maintain a significant degree of government control over the economy. In the 1980s, the US and the UK underwent substantial financial reform, opening up their economies and capital markets to the idea of free trade of goods, services and capital. With regards to currency or exchange rate regimes, the conventional wisdom has gone from governments trying to maintain control to allowing freely floating exchange rates. A slight fine tuning of this in the wake of the currency crises of the 1990s is the idea of the “bi-polar” world so eruditely explained by Stanley, former First Deputy Managing Director of the IMF, in speeches and written research notes. This argues that in a world of open capital accounts and free trade, exchange rates have to be managed according to either the hardest of pegs or the freest of free-floating principles, that anything in between these two poles will eventually prove unsustainable. Whatever the merits of this argument, there is little doubt that it has become the conventional exchange rate wisdom of the day, notwithstanding the protests of a few dissident voices.
The conventional exchange rate wisdom of the time of necessity affects the way markets operate, and thus how markets speculate for or against currencies. For instance, market participants who have been used to making good profits by speculating against pegged exchange rates may try to do so again, against a currency peg in a completely different part of the world. To a very large extent this is self-fulfilling. For this reason, a currency board regime that gets attacked in one part of the world can lead to markets attacking other currency boards on the other side of the world. For this very reason, the currency boards of Argentina and Hong Kong are often linked, although that link has been gradually reduced in the market’s mind as the Hong Kong authorities have proved time and again their determination to maintain the currency board. Currency speculators trade currencies to make money, pure and simple. They have a variety of methods, which we will look at subsequently, but the incentive is always the same. The fact that they can do so in the reasonable expectation of achieving their aim causes a problem with standard economic theory, not least because the theory suggests it is impossible over time. According to the theory, currency speculation is zero sum gain, which of necessity cannot result in consistent excess returns given the unpredictability of currency markets. The fact that excess returns can and have been achieved suggests this theory needs to be amended!