Should you adopt UBS' FX strategy?

One thing you can say about the foreign banks: when it comes to investment advice, they have balls. While the local banks and brokers tend to issue generalized, cautious weekly reviews, tweaking this avenue or that investment, the foreign banks leap out onto a limb and propose precise, detailed investment programs. Nor do they shy from ones that might blow up in your face.

Take UBS' advice regarding Israel's currency market, issued on June 29. The bank thinks the shekel will change direction and appreciate against the dollar. But it doesn't leave things there.

To take advantage of the trend, UBS suggests betting against the dollar through 3-month forward contracts. Enter at NIS 4.2425 and exit when the dollar sinks below NIS 4.05, it says.

UBS knows full well that its forecasts may miss. The dollar could be the one that appreciates, not the shekel. It therefore counsels investors to place a stop-loss at NIS 4.364.

A forward is non-tradable contract that you enter with your bank. (You can't buy one on the stock market.) The contract exchanges two currencies at a given exchange rate on a future date. You don't need to invest money to enter the contract, but the bank will demand collateral to cover potential loss.

Stop-loss, as its name implies, is an order lasting throughout the contract's lifetime. If the currencies move against you, it kicks in at a pre-defined level and stops your loss from growing. For instance, the bank may advise that it be automatically ordered to sell if the dollar appreciates by say 2.5% against the shekel.

UBS explains that no material change has taken place in world markets; U.S. interest rates are not expected to rise dramatically and foreign money will resume flowing into Israel, after exiting in net terms in the last month. Therefore, the analysts conclude, the shekel will gain strength and there's even a chance that the trend will accelerate if the Bank of Israel raises interest rates on the shekel next month.

UBS does not shy from listing potential risks, including security-related ones. But it thinks the risk level is low. It lists 15 events of security-related events in recent years, starting from Arafat's death to the Second Lebanon War and Hamas' conquest of Gaza, none of which materially affected the shekel.

Last in line: You

Is UBS right? Not everybody agrees. Shekel-dollar traders do feel that the  shekel's sudden dive against the dollar, or the dollar's rebound against the shekel if you well, during the last two weeks has ended. That fits with UBS' thesis.

But some foreign banks disagree about the rest. What is clear is that UBS' strategy may suit major hedge funds and speculators, but it's not the thing for the Yossi in the street, even the daring among them. Why?

First of all - timing. UBS published its report last Friday, since when the shekel has soared to NIS 4.20 per dollar. Much of the potential profit in the strategy has already disappeared. That is how it works in the financial markets: fast and furious.

When a new idea appears, the first to use it are the traders of the bank itself, then its big clients, and only then is the idea disseminated among the public. Some would call that a manipulation and that the public entering at the tail-end is the one that generates profit for the big boys that got in first.

Second of all - mechanism: A share can explode in price. At most exchange rate twitch by a few percent. To earn big amounts in the currency market, you have to bet big amounts.  You have to borrow heavily or provide huge collateral to operate through futures, which is what UBS' forwards strategy boils down to.

Also, you have to have the clout to minimize the buy-ask spread at the bank, which is the other party to the deal.

Almost none of the general public has that kind of power. Most people can't make money on deals like these and would be well advised to stay away. Confident though UBS may be in its idea, history shows that even the pros usually don't consistently profit from forex games. The only ones who do are the banks that supply them and us all with service.