Man, what a week, right?
We all watched the world markets take a pretty bad beating. The Dow Jones Industrial Average plunged a horrific 635 points Monday and another 520 points on Wednesday, taking the blue-chip index to a level it hasn't seen since last September.
Markets in Europe and Asia tumbled as well, leaving investors shell-shocked.
It reminds me of how the markets reacted after the 2008 collapse of Lehman Brothers Holdings Inc. (PINK: LEHMQ).
Investors panicked. They dumped nearly everything. Stocks fell 29% in three months. Commodities fell an incredible 47% that autumn.
At the time, you couldn't turn on even the local news without hearing something negative about the markets.
But I'll let you in on a secret: I loved every minute of it.
I made a nice 52% profit in my personal forex account that fall, all thanks to the increased volatility in the markets.
Yes, the very thing that sunk stock and commodity prices caused my forex trades to soar higher and faster than ever.
It wasn't an isolated event, either. There are plenty of ways you can profit from volatile swings in the stock markets with foreign currencies.
Take now, for instance. As of this week, volatility has emerged in the markets with a vengeance. But that's exactly the kind of volatility that rewards traders. In just a moment, I'm going to show you how to use this volatility to your advantage.
Don't Be Vexed by Volatility
If you're a market guy, volatility is downright entertaining to watch.
It's when you get the biggest swings on the charts. You can see the exact moment when stock prices start to plummet. You can almost visualize the big institutional traders getting up and leaving the market when that happens.
You can also measure this volatility fairly easily.
You can measure how volatile the Standard & Poor's 500 Index is by watching the VIX (the Chicago Board Options Exchange's Volatility Index). When the index rises, stocks become more volatile. When the index drops, stock market swings calm down.
The ideal stock market climate for investors is "low volatility with an upward trend." The worst case, nightmare scenario is when there is "high volatility and a distinct downtrend trend."
I believe we're seeing the latter scenario now. Again, that's bad news for stock investors, but great news if you're trading currencies.
But back to the VIX for a moment. Historically, the VIX usually ranges from around 15 on the low side to around 35 on the high side. This week it's actually traded over 40.
Once you know how to gauge volatility, you just need to know which currencies to trade to take advantage of it.
A Winning Currency Trade
During the credit crisis, I stumbled across a currency pair that I hadn't watched much before. But one day, I noticed this pair looked exactly like the VIX. When the VIX rose, this pair rose and vice versa.
It was the GBP/AUD, or the British pound vs. the Aussie dollar.
When the VIX rose, the Aussie dollar dove so hard vs. the British pound that the GBP/AUD pair ended up mimicking the VIX.
So as volatility rose, I bought the pair.
I simply used the VIX as my "temperature gauge" to give me signals on when to buy the GBP/AUD pair.
Well, when the VIX went nuts and this pair shot up like a rocket! The GBP/AUD gained 6,500 pips from July 2008 to October 2008.
It's been a similar story this time around. In the past seven days, the GBP/AUD pair raised an incredible 962 pips as stocks took a serious beating. All totaled, the GBP/AUD pair has risen 1,562 pips since Aug. 2.
While that's a lousy sign for the stock market, it's a great sign for the GBP/AUD and its upside potential. Going forward, this GBP/AUD pair has the potential to soar even further if stocks keep dropping.
As you can see, the right currency plays can offer you a measure in safety in times like this.
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