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Trading the US Dollar and the Japanese Yen

One of the most active foreign exchange markets is the Japanese Yen and the US Dollar is one of the most extensive on the foreign exchange markets. That’s not surprising as the US and Japanese economies are, respectively, ranked first and third in the world and do a huge amount of business with each other.

Currency traders have long played in these markets. They back their hunches about the next movement up or down, seeking profit from the shifts between these two mighty monetary blocs.

But is trading the dollar/yen be right for you? To help you decide, take a look at how dollar/yen trading works.

The basics of trading the dollar/yen

There are 3 ways you can trade the dollar against the yen.

  1. Literally exchange one currency for the other. You can do this through a trading account with a financial services company or through your bank.
  2. Futures and options. These derivatives allow you to bet on exchange-rate movements without taking delivery of the currency itself. Derivatives, however, can be risky if the rate moves significantly in the ‘wrong’ direction.
  3. Currency Exchange-Traded Funds (ETFs). These are listed on stock markets and trade just as if they were company shares. In the case of currency ETFs, the fund has bought the currency in question so you don’t have to.

All three of these trading options are available on eToro

What do I need to know about the foreign-exchange market in general?

  • It is a zero-sum market. That means that when one currency rises, another must fall. Exchange rates are reference numbers – unlike share or bond prices, they cannot all go up or down at the same time.
  • A currency rate is the price at which one currency can be exchanged for another. As a currency strengthens, it takes less of that currency to buy another. The reverse is the case when a currency weakens.
  • All foreign exchange is traded in ‘pairs’. To buy one currency the trader needs to sell another, unlike shares or bonds.
  • Many factors affect the strength or weakness of a currency. A major one is the performance of its economy. A successful economy will produce goods and services that people in other countries want to buy. In order to pay for them there will be a flow of funds out of the other countries’ currencies and into that of the successful economy.
  • The prevailing rate of interest in a country is another factor. Higher rates tend to attract funds from abroad, pushing up the value of the currency.

Economic influences on the dollar/yen relationship

The yen is the currency of a major exporting nation, one that is forecast to run a surplus on its trade with the rest of the world this year of 3.3 per cent of gross domestic product (GDP). The dollar is the currency of a major importer, predicted to accumulate a deficit of 2.7 per cent of GDP.

This means you, as a currency trader, need to bear in mind the different priorities of the US and Japanese governments and central banks. Japan wants to keep the yen low, to make its exports cheaper when priced in local currency terms. The US, meanwhile, has long been concerned that it is being unfairly priced out of overseas markets by deliberate under-valuation of other currencies.

How has the exchange rate behaved recently and what has affected it?

In the ten years to February 2017, the rate was as low, from the US point of view, as 75.75 yen and as high as 125.6 yen. The reverse was true for Japan, as far fewer yen were needed to buy a dollar when the latter was at its low point. In mid-February, the rate was about 114 yen to the dollar.

Given US official interest rates had been raised while those in Japan remained at zero, traders will not have been surprised by the relative strength of the dollar.

And this takes us to another special feature of the dollar/yen trading relationship – the ‘carry trade’.

This is where investors take advantage of rock-bottom Japanese interest rates to borrow in yen and re-invest the money in other currencies backed by higher interest rates. This impacts the strength of the yen against the dollar.

What are the pros and cons of trading the dollar and the yen?

Pros: this is a very liquid market featuring two huge currencies issued by politically stable democracies. You are unlikely ever to be short of buyers or sellers.

Cons: all currency relationships are prone to interference by politicians and central bankers and these two are no exception. Foreign exchanges are also notoriously influenced by gossip and rumour.

Is trading the dollar and yen right for you?

If you’re reasonably sure your hunch about the next dollar/yen movement is right – perhaps because you have studied charts of previous patterns – then it may be. Drop in on some dollar/yen traders on eToro and see what their latest thinking is.

Technical Analysis for USD / JPY