Foreign Exchange Market Currencies

While CTAs are attracted to the skyrocketing returns exotic chart conversion currency foreign provide, the risk of substantial losses should not be taken lightly. So just what is the proper mix?

Go where the action is. Any futures trader would offer this advice to a novice. So where might that be? Considering that in 2006 the daily turnover for the foreign exchange market reached $ 1.2 trillion, currencies might be the answer. Forex can be considered a hit or miss market - many commodity trading advisors (CTA) still would like to forget the pains it brought in 2005 - but today, it's a good venture.

Having three bad years when it's difficult to trade caused several money managers to decrease allocations to currencies, says the, president of John W. Henry & Co. (JWH) in Westport, Conn. “But at our firm, we more or less increased our exposure because of the last couple of years. Currencies were good in 2005 for us as well as in 2006.” JWH's forex program captured the number two spot on Barclay Trading Group's more than $ 10 million under management top trader list in 2006, returning 71.7%.

CTAs, whether they trade currencies as a separate program or within a diversified portfolio, have an abundance of choices, including what crosses to trade, when it's appropriate to add exotics and whether to trade through the interbank or the exchange.

For some, the decision regarding exotics comes easy. “We look at inflation, interest rates... There are about 18 different variables that come into consideration under the model. We feel for the exotic currencies this data isn't available,” says the director of client relations of Los Angeles-based Analytic TSA Investors, which trades currencies on the International Monetary Market. “We just [won't] compromise the integrity of the program.”

Lack of clean data is the most prevalent reason for avoiding the exotics. Nevertheless, the Southeast Asian currencies, which fall in the exotic category, came to the rescue of some top traders in 2006, including Tactical Investment Corp. in Hawaii and Tamiso & Co. in New York. Last year, Baltimore-based Campbell & Co. added the Hong Kong dollar, Indonesia rupiah, Mexico peso, New Zealand dollar and South Africa rand. While Campbell's decision partly stems from the need to make up for cross-rates that might be lost to the single European currency, like any new market, the firm chose the currencies based on its ability to complement the return-to-risk ratio.

San Diego-based Trendview Management says the majority of its 54% return on its world currency program in 2006 came from the exotics. The program has included less common currencies since 1990, when the Trendview's principal, added the Spanish peseta and Italian lira. Smith says he expects the popularity of the exotics to grow tremendously in the next five years because many of the European currencies are highly correlate and the exotics offer diversification.

“We will see the biggest opportunities in Eastern Europe, Southeast Asian and Latin America”, says the principle, who trades about eight of the less common currencies.