Who should consider trading the British pound/Australian dollar?
Anyone with a particular view on the relative likely performance of the two economies. The countries are old friends and allies, but their economic fortunes are not always aligned.
Someone who believes the Australian dollar has never really shaken off its role as a proxy play on commodities such as iron ore and thinks they know which way resources prices are going.
Day traders. In the movements between these two currencies, issued on opposite sides of the world, the quick-witted trader can try their hand at making a profit.
What do I need to know about the British pound and the Australian dollar?
Sterling is a very much bigger currency than the Australian dollar, not surprising given the relative size of the two economies, with gross domestic product (GDP) of $2.8 trillion and $1.19 trillion respectively.
While the pound is a reserve currency, sitting on the books of central banks around the world and helping to underpin the International Monetary Fund’s operations, the Australian dollar is not. This, however, may be an advantage for the dollar, as it is less widely traded, so potentially less vulnerable to speculation, and less prone to shifts in political sentiment.
The Australian dollar used to be…a pound! The name was changed in 1966.
The enduring stability of Anglo-Australian relations has not been mirrored in the relationship between the two currencies. During the last 10 years, the pound’s purchase power has swung round from a high of about 2.65 dollars down to 1.44. Until the early 70s, Australia was part of the sterling area, a currency bloc based on the Commonwealth that conducted business in the British pound.
What are the factors that affect the exchange rate between the British pound and the Australian dollar?
Relative interest rates. In recent years, Australian rates have been considerably higher than those in force in the UK. That is in large part because the financial crisis had far less impact in Australia than in countries such as Britain, therefore there was less need for ultra-low rates to stimulate the Australian economy. These higher rates made dollar-denominated assets more attractive.
The carry trade. These rates also prompted some investors to borrow in low-rate countries such as Britain and transfer the proceeds into higher-rate locations such as Australia. Economic theory suggests that any interest-rate gain ought to be wiped out by an exchange-rate loss, but with good timing this can sometimes be avoided.
The respective economic performances of Britain and Australia. The boom in emerging market economies earlier this decade was good news for Australia, as its commodities fed an apparently-insatiable demand from the likes of China. More recently, the slowdown in emerging-market growth has seen unemployment remaining high as it has been falling in the UK. Now, the dollar exchange rate is depreciating, which should help exports.
Commodity prices. Australia is a modern service-based economy with a strong banking system, but it also remains a major exporter of commodities such as bauxite, coal, iron ore, gold, diamonds and tin. It may no longer make sense to treat the Australian dollar as a pure commodity play, but neither can this aspect be ignored.
The basics of trading the British pound/Australian dollar
Open a trading account with a financial institution or simply buy or sell pounds or dollars through your bank. Visiting a high street money exchange and taking possession of the actual banknotes is not very practical, however satisfying it may feel.
Use futures and options, derivative products that let you take positions on exchange-rate movements without having to own the currency itself. But if you call the movements incorrectly with futures trading, you could lose more than your stake.
Use contracts for difference (CFDs). These have become the most popular method to trade on all kinds of financial markets. A CFD is, as the name suggests, a contract between a trader and broker to pay each other the difference between the price of an asset on the day the contract is signed and the day it is terminated. They are leveraged products, meaning you can gain exposure by investing only a percentage of the full value of the trade you want. Whilst this gives opportunity for greater profit, you risk losing more than your deposit if the market moves against you. A second risk is that rapid price changes can cause your account balance to change quickly. If you do not have enough funds in your account to cover these situations, there is a risk your position may be closed automatically when your balance falls below a certain level, known as the close-out level. Stop-orders can limit risk but, in fast moving markets, prices might rise above or fall below the desired level before a sale can be executed. This may increase losses.
eToro offers CFD trading in British pound/Australian dollar
What do I need to bear in mind about foreign currency trading in general?
Currency rates are reference numbers – they refer only to each other, not to some external measure. That means for every currency whose value goes up, another’s must go down. This is because the only item with which you can buy a currency is another currency. In that sense, currencies are quite unlike other asset classes.
Exchange rates are prices, and can be influenced by many things, whether that’s the economic outlook for a particular country, its inflation rate (the rate at which its currency is losing purchasing power) and political stability or lack of it.
What should I consider regarding trading the British pound and Australian dollar?
These are two well-established and well-regarded currencies issued by members of the Group of 20 leading economies. The market for both is liquid and reliable. But the relationship between the British and Australian economic and financial cycles can be hard to read, and the value of the Australian currency is complicated by the fact that most of its valuable resources are priced in US dollars.
Is trading the British pound/Australian dollar right for me?
It may be, provided you are confident that you have a good overview of the relationship between the two currencies and can navigate it successfully.
*This content is intended for educational purposes only, and shouldn't be considered investment advice.
*Past performance is not an indication of future results. All trading carries risk. Only risk capital you're prepared to lose.