By SARAH MORGAN
After the close of> New York trading Wednesday, the yen hit a record high against the dollar. The move caught currency traders across the globe by surprise and offers a few lessons, especially for the growing number of retail forex investors.
Even for the fast-moving world of currency trading, yesterday's move was unusual. The yen's price set a new record, the 4% rise happened within just a few minutes, and finding buyers for the falling dollar became unusually difficult. The move occurred when both the New York and Tokyo markets were closed, the quietest part of the 24-hour currency trading day, and the difference between the price buyers are willing to pay and the price sellers are asking, known as the "bid-ask spread," widened to as much as 50 cents far more than the 1 or 2 cents that is typical. "I've literally never seen that before," says David Rodriguez, a quantitative strategist for DailyFX.com.
It seems counterintuitive to think a disaster like the one still unfolding in Japan would cause a country's currency to rise, but that's exactly what's happened, says Andrew Busch, a currency strategist with BMO Capital Markets. Japanese companies have been selling foreign investments to have cash on hand to deal with the crisis, Busch says. When they sell those foreign assets, they sell dollars or euros or another currency and buy the yen. When there are more buyers for the yen, prices rise. On Wednesday, once the dollar fell past its previous low, both institutional and retail traders' stop orders were triggered, intensifying the slide, he says.
Rumors about the reason for Wednesday's move highlight how much money is at work in the currency market and how small an individual trader is in comparison to the total market. There's some speculation on the street that one or more major institutional traders had bought options that would have meant a big payday if the dollar fell to a certain level and in a period of unusual yen strength, took advantage of the low liquidity at the end of the day to nudge prices far enough to cash in those options, Rodriguez says. But even during periods of low liquidity, the dollar-yen pair is one of the most liquid tradeable assets in the world, with a daily turnover volume of $570 billion, so it's unlikely anyone could have that kind of effect on prices, says Camilla Sutton, the chief currency strategist for Scotiabank.
For U.S. forex traders, many of whom are fairly new to currency, the yen's unusual move also underscores the difficulty of trading in a volatile market. Traders often use stop orders, which are orders to automatically sell out of a position at a certain price, to limit potential losses. If you buy the dollar and it falls past your stop order, you are automatically sold out of the position to prevent deeper losses. But in the case of a sharp, sudden drop like this one, a stop order might have locked some traders into losses without allowing them to wait for the dollar to rebound from its record low.
Wednesday's move also shows that now when the yen is exceptionally volatile is not the time to place big bets. "Through significant market uncertainty, my best suggestion is just to limit position size," Rodriguez says. In an unpredictable situation like the crisis in Japan, traders should make smaller trades, anticipate bigger price swings, and place stop orders wider than they normally would, to accommodate those bigger moves, Busch says.