How to trade USD/ZAR: trading strategies and tips
In this article we look at tips and strategies related to trading the exotic USD/ZAR currency pair, identifying the concepts and tools used for day trading and hedging this market.
USD/ZAR: what you need to know
Exotic currency pairs and liquidity
The USD/ZAR is what is referred to as an exotic pair in currency trading or forex trading, as the rand component (ZAR) is an emerging market currency which carries less liquidity than that of developed market currencies.
Exotic currencies, because they do carry lower liquidity than major most traded market currencies (the US dollar, Swiss franc, euro, British pound, Japanese yen, Canadian dollar and the Australian dollar), will carry a wider spread and in turn, a higher cost to trade. However, the lower liquidity does offer higher volatility and in turn, a higher reward (or loss) opportunity on offer.
That said, the South African economy is more developed than a number of its emerging market peers and in turn, the liquidity is considered higher than many of these counterparts and more than sufficient for trading purposes.
USD/ZAR trading strategies
There are two major approaches for trading the forex market, including hedging and speculating.
Hedging with the USD/ZAR
Some traders might wish to use the USD/ZAR pair to hedge their currency exposure for an asset purchase or funds received in USD. This allows them to lock in the current exchange rate and helps to avoid currency fluctuations.
Steps for hedging:
- Determine currency pair
- Determine direction
- Determine size
A South African investment banker working for a US investment bank is told at Christmas that he will be receiving a bonus of $1 million in June.
As he lives in South Africa, he wants to transfer this bonus into rands (ZAR). The current rate of USD/ZAR is very favourable for him and he does not want to run the risk of the dollar weakening or rand strengthening significantly between now and when he receives his bonus.
Therefore, he wishes to take out a CFD trade to hedge his exposure to the USD/ZAR exchange rate between now and June, when his bonus is paid. If the dollar weakens against the rand, he wants to be compensated via his CFD trade, an amount equal to the reduction in value of his dollar bonus.
Traders of the USD/ZAR (as well as other forex pairs) are given the opportunity to long or short the currency pair. Taking a long position would mean we expect the dollar to increase its value in rand terms, while taking a short position would mean we expect the dollar to decrease in value in rand terms.
Therefore, we know he needs to short the USD/ZAR, to benefit from dollar depreciation in rand terms, but we need to work out the size of the trade he would need:
Let’s assume the current USD/ZAR rate is R14/$.
One standard USD/ZAR contract (the largest USD/ZAR contract on offer by IG) would give the banker an exposure to $100,000. To cover the banker’s bonus, he would need exposure to $1,000,000 (R14 million).
Therefore, to protect his upcoming bonus from a weakening dollar or strengthening rand, the banker would need to short 10 x USD/ZAR contracts.
(1,000,000 exposure/100,000 per contract = 10 contracts)
In this scenario, if USD/ZAR was to decline (as was expected) over the period leading into the bonus payout, the banker would have protected the value of his dollar bonus in rand terms, thereby having successfully hedged his bonus.
If, however, the USD/ZAR was to rise over the period, the banker would not have successfully have hedged his bonus.
Speculative trades with the USD/ZAR
Speculating on the USD/ZAR currency pair quite simply means that the trader is taking a view that the currency pair in question is going to rise or fall over a specific period of time. Unlike with hedging, the trade is not linked to the protection of another asset, i.e. a bonus.
Speculative traders often adopt a day trading (below) or swing trading strategy (We will explain in How to trade USD/ZAR part two) for the USD/ZAR.
Day trading the USD/ZAR using technical analysis
Day traders, as the name implies, are concerned with trading intraday, i.e. entering and exiting their positions (perhaps multiple times) within the course of a day, not carrying their respective positions overnight.
There are a number of technical analysis methods to trading instruments like the USD/ZAR. For day traders, breakout strategies remain popular.
One such system is to look for a period of low-price volatility or consolidation and marking these levels with trend lines to highlight areas of support and resistance.
A series of small-bodied price candles often emphasises this type of low volatility period.
A breakout is considered when the price moves above or below the support or resistance level, preferably with a long-bodied candle. The long-bodied candle would suggest an increased volatility now resuming, while the breakout suggest the direction we would be looking at trading the USD/ZAR pair.
How news and monetary policy affect trading in the USD/ZAR traders
Traders will want to keep an eye on the economic calendars, as high impact news have the potential to highly impact the USD/ZAR currency. Knowing when these catalysts are going to occur gives us an expectation of when large moves may be realised in the forex market, giving the trader an opportunity to react.
When trading the USD/ZAR, traders will focus on both the high impact US and South African economic data points as the currency pair is reflective of the two economies. Gross domestic product (GDP), consumer price inflation, trade/current account balance and unemployment data would be among the key data points to watch in this regard.
There are a number of places, including the IG news section, where you can locate this data. Traders will be concerned with the expectations for these data points and whether or not the realised result is ahead or worse than the consensus estimates.
Currencies are most sensitive to monetary policy by central banks. Rising interest rates in an economy are expected to have a strengthening effect on the domestic currency, while lowering interest rates are expected to have a weakening effect.
News such as inflation data (in particular) will create the expectation of whether the reserve or central bank will be looking to tighten or loosen monetary policy. It is that expectation of monetary policy which is perhaps the most important to traders as markets price in now, what they expect to happen in future.
In the case of the USD/ZAR, we will look at the direction of the monetary policy in both the US and South Africa. Traders can follow IG’s news and trade ideas to keep an update on the central banks’ movement.
A summary of key strategy ideas when trading the USD/ZAR forex pair
- Speculation and hedging are two key trading strategies associated with trading the USD/ZAR
- Hedging strategies would be linked to asset purchases or further dated funds transfers, i.e. dollar into ZAR
- Speculators often employ day trading and swing trading strategies to trade the USD/ZAR
- Day traders might look for breakouts intraday following periods of low-price volatility
- Forex traders will keep an eye on the economic calendar to help with timing of events which may cause volatility in the currency pair
- News anticipates upcoming monetary policy decisions
- Tightening monetary policy is expected to strengthen the domestic currency
- Loosening monetary policy is expected to weaken the domestic currency