Use the UK to Make Money in the US with SPY and LDN

02/06/2009 10:33 am EST

Focus: FOREX

S. Wade Hansen

Co-Founder, Profiting with Forex (PFX) and Learning Markets

Every economy around the globe has been affected in one way or another by the global financial crisis. The difference is that some economies have been more adversely affected than others. This is certainly true when you compare what has happened in the United States with what has happened in the United Kingdom. If you look at the value of the British pound (GBP) compared to the US dollar (USD), and the health of the British financial industry compared to the US financial industry, it would appear that the UK is getting the shorter end of the stick.

Pitting One Economy Against the Other

As an investor, you can take advantage of this imbalance using a pairs trading strategy. When you use a pairs strategy, you find two investments that are relatively similar, and you buy the investment you believe is stronger, while selling the investment you believe is weaker.

In this case, the US is showing itself to be fundamentally stronger than the UK—which means the stocks in the US should perform better than the stocks in the UK.

To put this imbalance to work in your account, you could buy an exchange traded fund (ETF) that covers a broad range of stocks in the US, like the SPDR Trust Series 1 (AMEX: SPY), which follows the performance of the S&P 500, and simultaneously sell an ETF the covers a broad range of stocks in the UK, like the NETS FTSE 100 Index Fund UK (NYSE: LDN), which follows the performance of the publicly traded securities in the aggregate British market, as represented by the FTSE 100 Index.

Pairs Trade Results

When you use a pairs trading strategy, you are able to hedge some of your risk, but you also give up some potential gains in the process. That is the cost of reducing your risk.

Ideally, if you were to buy the SPY and sell the LDN, stock prices would increase, and you would make more money on the SPY trade than you would lose on the LDN trade, giving you a net profit on the pairs trade.

Of course, if stocks went down in general, you would hopefully make more money on the LDN trade than you would lose on the SPY trade. Check out the video below for more details.

By S. Wade Hansen of PFXGlobal.com and LearningMarkets.com

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