Who should consider trading the euro/yen?
Anyone with a well-grounded view of the respective prospects of the Eurozone and Japanese economies. Buying the currency in question would let them back a view that either the Eurozone or Japan is set to outperform the other.
Anyone seeking to hedge a position outside either the Eurozone or Japan. Someone heavily invested in Japanese stocks may seek diversification by buying the euro, and vice versa.
Day traders. Short-term, sometimes very short-term movements in the exchange rate open up brief but potentially lucrative opportunities for the fleet-footed.
What do I need to know about the euro and the yen?
One is a national currency dating back to the mid-19th Century. The other is still very much the new kid on the block, a multi-national denomination with a history reaching no further into the past than 1999.
The yen is not only the sole property of a single national government - in contrast with the 19-nation Eurozone - but it is subject to far more political oversight than is the euro or even sterling or the dollar.
Whereas Japan’s money serves a socially homogenous nation with a common language and shared history, the euro circulates in a polyglot currency union stretching from the Russian border to the Atlantic and from the Arctic Circle to the doorstep of Africa.
Yet euro/yen has proved an irresistible play for currency traders. For all the big differences, there are some common features. And those differences themselves can sharpen the excitement and the interest of taking positions in these two global currencies.
What are the factors that drive the euro/yen relationship?
Both the euro and the yen are members of the elite basket of reserve currencies maintained by the International Monetary Fund (IMF). This underpins the IMF’s in-house currency, the ‘special drawing right’. Others in the basket are the dollar, sterling and the Chinese currency, the renminbi.
The economy served by the euro is considerably larger than that of Japan, at about $12 trillion against $5 trillion. They are both, however, among the largest in the world and the two economies are major trading partners.
Both the European Central Bank (ECB) and the Bank of Japan (BOJ) are currently pursuing zero or even negative interest-rate policies. For different reasons, both the Eurozone and Japan have been plagued by sluggish or non-existent economic growth and believe themselves to be in need of monetary stimulus.
This is in contrast to the United States in particular and the UK, where monetary policy is more likely to be tightened than loosened. But it does make the euro/yen rate vulnerable to rumours or reports of a change in policy at either the ECB or the BOJ.
Because the Japanese authorities have a freer hand than their European counterparts, they are able to launch new initiatives with little warning designed to lower the value of the yen and thus increase exports. That could destabilise any position you may have taken on euro/yen.
Another potential source of volatility in euro/yen trading is the presence within the Eurozone of fully-fledged Group of Seven (G7) leading economies in their own right – Germany, France and Italy – all with their own national interests and agendas.
The basics of trading the euro/yen
The straightforward option is that of buying or selling a collection of euro or yen notes, either in their physical manifestation or, more sensibly, through a trading account with a financial institution or your bank. No, not an approach likely to win any prizes for financial innovation, but it has the merit of being easy to understand.
You could use futures and options, derivative products through which you can take positions on exchange-rate movements without having to take ownership of the currency itself. But if the trade goes ‘wrong’ – in other words, if your speculation is proved incorrect – then derivatives can be risky, and ultimately expensive.
Contracts for difference (CFDs). These have become the most popular way to trade on financial markets of all kinds. A CFD is a contract between a trader and a broker to pay each other the difference in the price of an asset from the day the contract is signed to 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.
What should I consider regarding trading the euro and the yen?
This is a well-established market in trading the currencies of two leading economies, those of the Eurozone and of Japan. It is a liquid market in which demand for euro or yen is highly unlikely to dry up. But these are two economies have their own problems and are in the middle of unconventional economic policy responses to try to restore growth.
A good feel for the interplay between them is essential for the would-be euro/yen trader.
*This content is for information and educational purposes only and should not be considered investment advice or an investment recommendation.
*Past performance is not an indication of future results. All trading carries risk. Only risk capital you're prepared to lose.