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We frequently get questions from our readers about how we handle exchanging foreign currencies while living in so many countries. And our standard answer was: a combination of a credit card with no forex fees and a checking account that reimburses foreign ATM access fees. This way, you could simply hold most of your wealth in one currency, then spend it frictionlessly all around the world!
And that system has worked out pretty well for us.
Why now? Well, while we were working the vast majority of our money was earned in Canadian dollars, so our portfolio was mostly in CAD as well. But lately, we’ve been earning more and more side hustle money, and for whatever reason the vast majority of THAT income is earned in USD.
So what that means is it’s become more and more necessary to exchange CAD for USD and vice versa without doing it via a purchase. For example, I recently had to do this forex exchange inside my brokerage account in order to rebalance my portfolio.
The problem with doing this via a bank or even a brokerage account is the hidden fees that get charged. Even when a bank insists on not charging extra fees to exchange currency, whatever the bank’s exchange will usually differ from the real exchange rate as reported by xe.com, usually by 2-3%. This spread is what the bank earns off you every time you do a currency exchange, and while being charged 2% to exchange a few hundred bucks before going on vacation isn’t such a big deal, when you start exchanging thousands or tens of thousands of dollars at a time, these fees start to add up.
Let me tell you about Norbert’s Gambit.
How Does It Work?
Norbert’s Gambit it a strategy some financial advisor (named Norbert I’m assuming) came up with that allows you to exchange foreign currencies at the actual, real exchange rate. It does this by exchanging the money using the stock market, therefore bypassing those thievin’ banks.
Here’s how it works.
In a world full of giant multi-national companies, it’s relatively common for stocks of a certain company to be listed on multiple stock exchanges. Royal Bank (RY), for example, is listed on the Canadian stock exchange (TSX) in Canadian dollars as well as the US stock exchange (NYSE) in US dollars.
Because these are shares of the same company, they will trade on both exchanges on two different currencies. But because traders on both stock exchanges are deciding the price rather than the banks, the relative difference in the two prices will reflect the actual exchange rate, rather than the marked-up one the bank will give you.
So how do we do use this to exchange money?
If a stock is listed on multiple exchanges (or “cross-listed”), and if you own that stock in one exchange, you can request that your brokerage transfer your ownership of that stock over to the other exchange. So for example, if you bought 1 unit of Royal Bank on the NYSE in USD, you could ask your brokerage to transfer (or “journal”) that unit over to the TSX, and then sell it in Canadian dollars.
Why Would You Do This?
Because the prices of the same unit are determined by the stock market and not the bank, Norbert’s Gambit exploits this to allow you to exchange money from one currency to another without paying any bank fees or foreign exchange rate mark-ups. Basically, the steps of Norbert’s Gambit are:
- Buy some stock units in your source currency
- Call up your brokerage and ask them to “journal” those units over to another exchange
- Sell those units in the destination currency
If done correctly, you’d be able to use this technique to exchange money from one currency to another and the only cost would be the trading commissions. This is especially useful with a brokerage like Questrade, who only charges commissions to sell ETFs, not to buy.
So if you were to exchange $10k CAD to USD, if you did it at a bank you’d lose 2%-3% to forex mark-ups, or $200-$300. But by using Norbert’s Gambit, you’d be able to do it for the cost of a single transaction ($5-$10).
A couple caveats to consider when attempting Norbert’s Gambit…
- Caveat #1: If the stock/ETF fluctuates too wildly in price over the course of the day, those movements may blow away any foreign exchange savings you get.
- Caveat #2: Depending on your brokerage, journaling shares takes time. For Questrade, it takes 1-2 business days. During this time, you will be subjected to the price swings of the underlying stock/ETF.
- Caveat #3: If the stock/ETF is not traded with sufficient volume which causes the bid/ask spread to be too wide, you may lose more money in the bid/ask spread than you save on the foreign exchange.
So an ideal candidate for Norbert’s Gambit would be a cross-listed stock that doesn’t swing in price often, yet is traded quite heavily. Fortunately for us, one ETF does exist: the Horizons US Dollar Currency ETF, or DLR.
This is an ETF that just holds USD and nothing else. It’s cross-listed on the TSX and the NYSE, and is heavily traded, yet doesn’t change in price wildly since it’s just holding a basket of cash.
So why does this ETF exist, you might ask? Specifically to use with Norbert’s Gambit! Horizon’s created this thing specifically so that people can use this technique to exchange cash back and forth!
OK now that we’ve introduced the technique, let’s talk specifics. Recently, as part of my year-end portfolio maintenance, I had to convert some money from CAD to USD. Let’s see how that went.
First, after pulling up my trading platform, I got a quote for the CAD-denominated version of DLR. At the time, it was trading at a price of $13.43 CAD per share.
On the US side, the same share was trading under the symbol DLR.U at $10.06 USD.
So that means that these two symbols (which again, are the same ETF under the hood) was reflecting a CAD-to-USD exchange rate of $13.43 / $10.06 = 1.335. At the time I placed this trade, Xe.com was reporting an inter-bank exchange rate of 1.334, so we are within 0.1% of the actual rate.
We start by calculating how much DLR we want to buy. At the time, I wanted to convert $10,000 CAD, so at a price of $13.43 per share, I needed to buy $10,000 / $13.43 = 744 shares.
After entering in our order, we wait for it get filled (which should be nearly instant because of the trading volume on this ETF). Note that even though Questrade doesn’t charge a commission for buying ETFs, I still got charged a small trading commission of $2.60 CAD from the exchange.
Next, I phoned up Questrade’s customer support line and asked for my shares of DLR be journaled over to the American side as DLR.U. Fortunately, the representative knew exactly what I wanted and put in the order. Note that it takes 1-2 business days after the trade settles for the journalling process to finish, so I had to wait until the DLR units disappeared and DLR.U appeared in my trading account.
Finally, once DLR.U shows up, I can then sell my units at the market price of $10.06 USD.
Note that I was charged a commission of $10.14 USD as a combination of Questrade’s trading commission and the exchange fees.
In total, I was charged $2.60 CAD and $10.14 USD on both sides of the trade, so all in all, I paid $9,991.92 + $2.60 = $9,994.52 CAD and got $7.484.64 – $10.14 = $7,474.50 USD.
So after fees, this means I managed to get an effective CAD-to-USD exchange rate of $9994.52 / $7474.50 = 1.337. Compares to the actual exchange rate of 1.334, that means I was able to get within 0.2% of the actual exchange rate.
So by doing Norbert’s Gambit, I was able to save the $200-$300 I would have lost by getting a marked-up exchange rate, and instead was able to do the trade for less than $20 CAD. Not too shabby!
The process for going the opposite direction is pretty much the same, only you know, reversed.
At the time of this exchange, DLR.U was again trading at $10.06 USD, and DLR was trading at $13.32 CAD, for an expected USD-to-CAD rate of $10.06 / $13.32 = 0.755. And on the date of my trade, the Xe.com reported exchange rate was…0.755. Spot on, spot on.
We start by calculating how many units of DLR.U to buy. At the time, I wanted to convert $5,815 USD, so that meant I needed to buy $5,815 / $10.06 = 578 units.
After that, I called Questrade and again had them journal over my shares. A few business days later, my journalling was complete and I sold 578 units of DLR to complete my trade.
For some reason, the commission I got charged didn’t show up on the screenshot, but on the buy side it was $2.02 USD, and on the sell side it was $7.84 CAD. So in total, I paid $5,825 + $2.02 = $5,827.02 USD and received $7,698.96 – $7.84 = $7,691.12 CAD. This means I got an actual USD-to-CAD rate of $5827.02 / $7691.12 = 0.757. Which compared to 0.755, is about 0.3% off. Fantastic!
The Big Short
Now you may have noticed that in my screenshots of my sell orders, it mysteriously says “Sell Short” at the top. Why is that, and what does that mean?
Recall that doing a normal Norbert’s Gambit means I have to buy the ETF on one exchange, request a journal, wait for it to be processed, and then sell on the other exchange. While I’m waiting, I’m exposed to price changes on the ETF and I don’t like that.
Granted, by using the DLR/DLR.U ETF, I’ve eliminated most of the wild price swings that affect normal stocks. However, I wanted to completely eliminate that risk, so I used a modified version of the strategy that I refer to as a “Long-Short Norbert’s Gambit.”
But before I get into that, I should probably back up and explain what shorting a stock means.
Normally when you buy/sell stocks, you exchange cash for units, or units for cash like a regular transaction you’d make at the store. However, in stock trading it’s possible to sell a stock that you don’t actually own. Under the hood, when you do this you’re actually borrowing units of that stock from the brokerage, then turning around and selling them on the open market. Your brokerage is going to want those units back, and in the meantime will charge you interest for lending them to you. This is known as “going short” or “shorting” a stock. Conversely, owning a stock in the usual way (paying cash for it) is known as “going long.”
Why have I never written about shorting stocks before? Because shorting stocks is normally a terrible idea.
What traders use this technique for is a strategy known as “short selling.” Basically, they borrow shares and sell them at the current market price, going into a negative balance on that stock, all in the hopes that the stock will fall in value. If that happens, they’ll be able to buy back that stock at a lower price, hand them back to the lender, and then pocket the difference. Essentially, short selling is a way for traders to bet on a stock’s price to fall in the short term, and because I’m not a day trader, I don’t do this or recommend that anyone do this.
However, in the very narrow case of Norbert’s Gambit, shorting a stock is how you reduce the risk of a sudden change in DLR’s price.
Basically, a Long-Short Norbert’s Gambit involves you buying (or going long) on your source currency’s units, and at the same time selling (or going short) on your destination currency’s units. As a result of this, you will be put into a situation of owning a bunch of units on one side of the trade, while owing the same amount of units on the other side. On my USD-to-CAD trade, this resulted in me holding a balance of 578 DLR.U, and a NEGATIVE balance of -578 DLR.
However, what this does is it eliminates the risk of DLR/DLR.U suddenly changing value. Since I’ve bought AND sold the same number of units at the same time, my holding period for this stock was only a few seconds. I’ve essentially locked in my exchange rate.
Then, I request my journal. A business day later, my long position journals over, and as soon as it does, my brokerage realizes I own exactly as many units of this ETF as I owe, so it uses that journal to repay my lender. This is known as “covering my short.”
However, it’s important to note that shorting a position isn’t free. My broker warned me multiple times that I was about to enter a short position…
And then helpfully informed me I would be charged for the privilege.
Taking on this short position cost me the equivalent of 9% annually in interest charges! This is why I don’t recommend shorting stocks as a trading strategy. The cost of holding that short position gets expensive fast. However, since we’re only going to hold this short position for a single business day, my cost is limited to less than $2. Which is a small price to pay to protect from exchange rate moves that could potentially ruin my strategy.
And We’re Done
So that’s it! Using Norbert’s Gambit to exchange money at the real interest rate for fun and profit! Now, I know that I’ve only talked about this on a CAD-to-USD exchange, but there’s no reason this won’t work for any other currency. As long as there’s a sufficiently traded stock that exists on two exchanges that trade in different currencies, this should work just the same.
Be careful though. If you do this with a normal stock, it’s even more important to do a Long-Short Norbert’s Gambit to eliminate the risk of day-to-day price fluctuations. Even though I jumped through all those hoops with DLR, at the end of the day DLR is unlikely to change all that much over a single day. The same can’t be said of a stock of a normal company. So be careful, and check with your bank/brokerage company that they know how to journal shares before you make any trades.
Questions? Comments? Let’s hear it below!
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