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Forex Trading – Month End Re-Balancing
Okay then, a couple of questions coming in about month entry balancing from Asanka, Dudley, and Yank who are all asking what is the month end and the quarter end rebalancing?
Now, looking at rebalancing, it basically comes down to the way that fund as well as money managers try to realign their books or their portfolios at the end of a month or at the end of a quarter.
So, fund managers has a very specific asset allocation in their portfolios that have specifically been selected to protect them from being either over-exposed or under-exposed on any given instrument or asset classes.
Now, most portfolio managers, as part of their books will have a specific benchmark, or let’s call it a target for the specific currency exposure that they want in their portfolio, but during the month, obviously we know that the value of different instruments and asset classes will change, including currencies, and that’ll obviously change throughout the month due to various factors, various sentiment shift, etc, thus at the end of the month the fund managers will need to basically realign or rebalance the currency exposures to make sure that they are not over-exposed or, let’s say, under-exposed on any given instrument whether that is the dollar, whether that is the yen, whether that is an equity class, et cetera.
So based on this function, many investment banks have basically created models to help them anticipate what type of rebalancing they can expect that should take place based on the performance of currencies and equities and other asset classes during the month.
Now, as the rebalancing is basically based on the difference in the movements that they saw in those asset classes, the size of the rebalancing will largely depend on the size of the volatility of the moves that we saw in those asset classes in the course of the month.
Now, the challenge for us as traders is that we don’t have access to the model itself. We just have access to the information given to us by the investment banks saying that they expect weakness or strength for a particular currency, and the other challenge we have is that we don’t know the size that is expected from these month end flows and what type of reaction it will have.
So, when we have seen lots of big moves in currencies during the month, that can be a slight indication that we might be expecting bigger rebalancing at the end of the month, but there’s no clear sure way for us to know that data. Thus, it’s good to include something like month end rebalancing in your analysis. It’s good to know exactly when that’ll take place, basically providing us with an opportunity to stay on the right side of those expected moves, but they are normally more low conviction drivers and they can be rather fickle and thus tricky to trade.
So, just keep that in mind going forward when you get any new information with regards to month end and quarter end rebalancing.