Now that the loonie is flying high again, many Canadians are considering US expenditures, which become cheaper as the loonie moves higher. Some of these purchases might be in the form of US stocks through your online brokerage.
But before you hit the trigger and jump on a position in Walmart (NYSE: WMT), Apple (NSDQ: AAPL) or Coca-Cola (NYSE: KO), make sure you understand the nature of currency risk on your trade.
Currency Risk When Buying US Stocks
Obviously, it is always better to buy your US stocks when the Canadian dollar is rising higher against the US dollar. The higher the loonie, the better – because it effectively makes the cost of purchase lower.
That’s easy enough, right? But what about when you want to sell?
You want the opposite to be true. You want the USD to be higher against the CAD than it was at the time you bought it. This is like having the wind at your back, because if the stock went up, it will feel like you made even more money (and you will have). And if the stock didn’t do as well, the higher USD will help offset the weakness in the stock.
But that’s also a little obvious in itself. Now, consider your entry point again.
Yesterday (March 16, 2010) the loonie was at 98.5 cents (approximately). I took advantage of it and bought two positions in U.S. stocks (not mentioned in this post). But if the loonie continues to rise, then my stocks have to do all that much better on the upside to outpace the improvement in the loonie. Make sure you understand how high the loonie can go.
Does that make sense?
Let’s say I bought some XYZ stock at $30.00/ share. If the loonie moves up to $1.05 against the USD (about 7 cents higher than where it is today), then effectively, it is as though my stock price just declined by an amount of the same order of magnitude (I won’t try to do the actual math here).
My XYZ stock needs upside potential of at least the amount of improvement in the loonie in order for me to see any real growth in it. It’s a somewhat simple point, but it hit home today when David Baskin explained how this works on BNN.
The bottom line: now is a great (relatively speaking) time to buy your US positions, but remember to consider how much upside you expect in the stock itself (in case our loonie keeps rising, which it probably will in the medium term). If you’re going to buy a utility, you might not see any real returns on it while the loonie is high.
The ideal would be to buy a U.S. growth stock on a good dip, while the loonie is also at a really nice high – especially if you expect the loonie to start trading downward again before you would be selling the stock (if at all). Then, if the stock and the USD both rise, you’ve got a nice springboard effect and a tidy profit if you decide to take it off the table.
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