Playing Stock Market Volatility with the Mexican Peso
Mr. Market is a very tricky character.
He always does what you least expect.
Take last year, for example. The consensus at the beginning of 2011 was that global economic growth would be healthy, and that it would be a good year for stocks.
We all know it didn’t turn out that way. The market had lots of ups and downs, and finished the year at breakeven.
This year started with the consensus that global growth would face a lot of challenges, so stocks and commodities would have a tough time. So the least thing anyone expected was for the market to begin the year with a big rally in stocks and other risky assets.
And of course that’s exactly what we’re getting. That’s how Mr. Market operates. And that’s why it pays to bet on unpopular assets. It’s no different in the currency market.
One of the most unpopular currencies has just started a big rally.
It’s Time to Love This Hated Currency
When looking for trading opportunities, it’s always a good idea to start asking “what is it that everyone hates right now?”
Late last year, I asked myself that question. What is the most hated emerging-market currency right now?
The Mexican peso was on the top of the list. It was one of the worst-performing currencies of 2011, losing about 18% of its value just in the second half of the year alone.
That’s a huge move in the currency market. To put it in perspective, the euro, also a contender for the most hated currency in the world, lost less than half of that during the same period.
The least thing anyone expected late last year was for the Mexican peso to start a big rally. So I jumped right into the trade.
There are two particular assets that helped me make that decision. Let me explain.
Finding Something Fishy in the Charts
When I trade the Mexican peso, I always have to check how two other assets are doing: stocks and oil. The reason is simple.
The Mexican economy still depends a lot on the U.S. economy. We buy about 80% of their exports. So if our economy is doing well, their economy tends to do well too. So far this year, economic data has been surprisingly strong in the U.S. No wonder stocks have been rallying.
The Mexican government is also very dependent on oil revenues. As a major oil producer, its economy tends to do well when the price of oil is rising.
So both the stock market and oil have been rallying. With the S&P 500 trading above 1,300 and oil above $100, the Mexican peso should be shooting through the roof, right?
But it didn’t happen. Check out the chart below.
Mexican Peso Has a Lot of Catching Up to Do
Please click here to view larger image
It’s clear there’s a pretty strong correlation between the Mexican peso, stocks, and oil. They moved together for the past 3 years. But while oil and stocks started a major rally in October of last year, the peso just moved sideways and was left behind.
It didn’t make any sense.
It’s Not Too Late to Profit
The Mexican peso is only now starting to move in the “right” direction. So it still has a long way to go catch up with the S&P 500 and oil.
An easy way to profit from that in the spot market is to short the pair USD/MXN. By shorting the pair, you will be betting the peso will appreciate against the dollar.
In fact, that’s exactly what I did when I saw this divergence in the chart. I recommended that my Exotic FX subscribers buy the peso.
We now have open profits of about 60%, using 20:1 leverage. And we’re shooting for tripe digit gains.
But it’s not too late to bet on the peso.
According to my analysis, the pair USD/MXN will move down to 12.90, at least. That’s a potential profit of 50% from current levels, using 20:1 leverage. And if stocks continue to move higher, the pair will drop much lower than that. It is now oversold, but I would short USD/MXN on any pullbacks.
This year we will see lots of ups and downs in the S&P 500. Trading the Mexican peso will be one of the easiest ways to play that volatility in the stock market.
Stocks have started the year on the right foot. And so has the peso. Until very recently, everyone hated the Mexican currency. But now it’s starting to get some love.
Under this positive investment sentiment, the peso remains a very good bet.
Editor, Exotic FX Alert and Currency Capitalist
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