Monday April 27, 2020 - 21:19:52 GMT
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Forex View: Expect Month End US Dollar Selling
Have you ever heard of the term “month end rebalancing?”
According to Investopedia, Rebalancing is the process of realigning the weightings of portfolio of assets. Rebalancing involves periodically buying or selling assets in a portfolio to maintain an original or desired level of asset allocation or risk.
Many international equity managers like to minimize the forex exposure of their equity portfolio and put on forex hedges to reduce that risk. Thus, at the end of each month they adjust the size of their hedges to bring them back into line with the current size of their portfolio.
For the forex trader, the focus is on whether forex hedges need to be reduced or increased. As a rule of thumb, if US stock prices increase during the month, short dollar hedges need to be increased (I.e. dollar selling) and vice versa if US equity prices fall during the month (I.e. dollar buying). Some adjust the hedges dynamically during the month and others do it on the last trading day of the month. Our focus is on the latter.
For example, say a foreign fund manager is long $1 mln worth of US stocks at the end of March and fully hedges the forex risk by being short the equivalent US dollars vs. his base currency (e.g. the euro). Stocks rise sharply by 10% during April and the stock portfolio is valued at $1,100,000. This leaves the fund manager under hedged by $100,000 so he has to sell that amount of dollars (e.g. vs. the euro) to fully hedge the forex risk.
End of April rebalancing
If US equities maintain strong April gains into month end, the assumption is that there will be dollar selling to adjust forex hedges.
How to use this knowledge to trade
Logic says the prospect of month end dollar selling, at a minimum, suggests there should be a limit on the dollar upside, especially the closer we get to month end and on April 30 as well. While much depends on other news and trends, traders will assume month end dollar selling. This knowledge can prove invaluable to forex traders.
Note on month end (I.e. April 30), most if not all rebalancing of forex hedges are completed by the 4 PM London fix.
In any case, we are not privy to the actual flows so all we can do is assume rebalancing this month will lead to dollar selling due to the sharp rise in US equities. As an outsider, we will be on the lookout for month end dollar selling without knowing in advance vs. which currencies will be in demand.
If you are looking for clues to which currencies are to be bought and the timing of such flows, you need to get access to the Amazing Trader. I have found it to be the closest I can get to trading as if I have access to inside information without being privy to the actual flows.
Please feel free to contact me with any questions or comments.
[email protected] view.com
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