Fund manager use forex to balance their portfolios, Max Munroe in Forex Round-Up
What happens is that all of the equity funds around the world, such as pension funds, need to readjust their nicely balanced portfolios so that they actually balance.
Let's say we have a pension fund that is 'passive'. In other words, all it does is invest in the UK FTSE 100 index and the US S&P 500.
Now let's assume that the passive portfolio has an equal weight in both, but during the month the FTSE outperforms the S&P. In other words, the UK FTSE index gains more in percentage terms than the S&P index
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Technically, the fund will now have more invested in the FTSE index than the S&P index. So it will need to re-balance itself.
In order to do this, the portfolio manager can sell pounds (GBP) and buy US dollars (USD).
The easiest way to do this is by selling GBP/USD which does this process for him, meaning he can then use a forex position each month to re-balance the portfolio.
What this in turn means is that, at the very end of the month, you will see a flood of GBP/USD orders which could result in pushing the market in one direction or the other.
So how can you use month-end flows to your advantage?
Well, the first thing to note is that these month-end flows always happen at the end of the month. No surprises there then.
This means that if you end up on the last day of the month moving in a bizarre direction, don't worry about it. Have a look at the relative indexes and see if it aligns to the month-end flows.
If it does these are simply one-day flows and you should ignore it.
The next thing to note is when the stock markets have increased significantly in the month and, more importantly, one country has significantly increased. For example, let's say there has been a great performance in the FTSE but not elsewhere.
In these situations, month-end flows could be much larger than normal.
Therefore going into the end of the month, either move stops up for positions you want to protect or make them wider so some crazy price action doesn’t hit you.
The slightly more fun route to go down is to actually use it to your advantage.
A way to play the month-end flow
Here you can look at the relative performance of the index and then determine the general direction for the month-end flow.
You can then use this to place a few trades at the end of the month as a separate strategy in order to capitalise on the movements.
Very simple one-day orders work extremely well for this. Simply place the trade the night before, just before the market closes, then let it run for the day.
Obviously you only get one chance a month to play a few of these trades. But this can actually be a real complement to your other systems and can add that little extra to your month-end performance.
It's one of the few real tricks of the trade.
So there you have it, how you can profit from the month-end forex flood.