By Samuel Soo– 28 September 2020
Getting into trading
Recently, I was thinking about how to answer this question – why trade and learn about the foreign exchange market?
When you think of trading, you might picture this: You start off by trading in your spare time, slowly accumulating net earnings, until you reach a point where you’re confident in making a living out of trading. Maybe you make a lot of money. Maybe you might go onto make a career out of it.
This ideal of ‘making it big’ from trading seems to be part of a marketing schemes used by online trading courses, resources and workshops offered by ‘successful’ traders (and you might ask yourself – why are they running workshops if they can make money off the markets?). Yet some of the world’s most reputed traders and hedge fund managers have walked down a similar path.
The foreign exchange market is repeatedly heralded as the most liquid market in the world, with the largest daily trading volume, and is active 24 hours a day, 5 days a week. The array of resources and trading platforms online means that the Forex market, now more than ever, is more accessible and accommodating to the everyday retail trader.
Whether your goal is to be able to make quick profit off the markets or pursue a lifelong career in trading and fund management, there is very little stopping you from starting out on that journey. That means that almost anyone can and should consider trading or investing in their spare time. The costs are minimal, but the rewards are whatever you set your sights on.
George Soros
Whenever I get interested in something new, I always like to look at some of the greatest people and stories for inspiration. George Soros is arguably one of the most successful traders in the world. I chose to focus on him as opposed to other big names like Warren Buffet, Bill Ackman or Carl Icahn because he made his money by trading in the Forex market.
Soros is most well-known for his $1 Billion short of the British pound sterling in 1992, on what is now referred to as Black Wednesday.
For context, the UK joined the European Monetary System (EMS) in 1990, an exchange rate regime that kept the bilateral exchange rates between European currencies fixed. The basis that currencies would remain fixed to was later formalised as a weighted average basket of currencies known as the European Currency Unit (ECU).
The exchange rate regime aimed to limit the fluctuations of European currencies against each other, serving as a precursor to the introduction of Euro, by deeming that currencies stay within a narrow 2.25% band of the ECU or a wide band 6% band of the ECU. In theory, this would allow countries to manage their bilateral exchange currencies with countries outside of the EU while keeping its exchange rate with other Eurozone countries constant. In practice however, the Deustche Mark (West Germany) and German Bundesbank (East Germany) dictated the EMS – Germany was able to independently adjust its monetary policy and exchange rates while other countries had to follow suit in order to remain within the band.
Before Britain joined in 1990, it was already struggling to maintain its exchange rates within this band as it struggled with high inflation rates, a double deficit (trade and budget deficit) and low labour productivity. When Germany increased its interest rates shortly in the early 1990s to combat inflationary effects on German reunification, this put downward pressure on all other currencies as capital inflows were reduced due to the interest rate differential decreasing.
In order to prevent the British Sterling Pound from depreciating against the German Mark, the Bank of England employed two strategies – buying up excess supply of British Pounds using foreign currency reserves to prop up the exchange rate, and increasing interest rates in an attempt to increase capital inflows and demand for the Pound. Both strategies came at a cost. Using large amounts of foreign reserves was not a sustainable strategy and limited the ability for the Bank of England to influence its exchange rate in the future. Increasing interest rates encourages saving and generally has a contractionary effect on the economy.
George Soros, among other speculators, believed that the Bank of England could not maintain its exchange rate in the EMS, and believed money could be made from its potential depreciation. Soros started by accumulating a short position by borrowing British pounds and purchasing mostly German marks.
His strategy also consisted of purchasing British equities, since equities tend to rise when a currency depreciates since exports become more competitive. He also bought German and French bonds while shorting their stocks, reasoning that an appreciation would prompt lower interest rates, making bonds appear more appealing.
On 15 September 1992, traders began a mass sell-off of the pound. The Bank of England attempted to purchase these orders to prop the currency off and announced that they would increase interest rates from 10% to 12%. But to no avail – it became evident that it could not maintain its exchange rate and on the same day it was announced that Britain would leave the ERM.
Soros’ positions ended up netting his fund $1.5 Billion in a single month. While Soros’ was not the only one who profited off the withdrawal of the Pound from the EMS, he is often remembered because of the sheer profit he made off this single event. Part of it comes down to how leveraged Soros was, which reflects how confident he was in his position.
Further reading
I spent a lot of time reading up on these topics to find the information I needed to write this article, but I also came across a lot of interesting information that I couldn’t fit in this article.
I learned about George Soros’ life, his childhood as a survivor of Nazi-occupied Hungary, his education at the London School of Economics studying philosophy of all things and his career path, working his way up to running his own hedge fund and even why he is now targeted as a scapegoat by right-leaning groups.
I learned about Black Wednesday, how the day unfolded and why it did. I also learned briefly about the history of the Euro and the European monetary system. I stumbled upon the Economics Review, a student run organisation at NYU that publishes articles, essays, and research papers, and I became more aware of student publications that I can look to for inspiration.
You can always learn something new if you are curious. If you are interested in learning more about Forex, and trading in general, subscribe to our weekly newsletter which explains the movements in the Forex market, and follow our publications for more articles like this.
References
• Inman, Phillip (2012) Black Wednesday 20 years on, The Guardian, URL https://www.theguardian.com/business/2012/sep/13/black-wednesday-20-years-pound-erm
• Scott, Justin K. G (2020) Black Wednesday: George Soros’ Bet Against Britain, URL https://www.thebalance.com/black-wednesday-george-soros-bet-against-britain-1978944
• Schaefer, Steve (2015) How George Soros Broke the British Pound, URL https://www.forbes.com/sites/steveschaefer/2015/07/07/forbes-flashback-george-soros-british-pound-euro-ecb/#66adc8be6131