Best Bets: Gaining Currency

Investors in search of high returns lately have been flocking to the foreign exchange, or  forex, market in droves.

Forex offers many advantages: quick returns, low or no cost transactions and 24-hour access to the largest unregulated financial market in the world. It is, however, a high-risk investment instrument.

So why the sudden surge of interest in foreign exchange? And is currency trading for everyone?

New Platforms

The increase in popularity among individual investors is partially the result of the proliferation of electronic currency trading platforms.

“Our business is all retail,” says Michael Cairns, head of risk management and trading at FX Solutions, an online currency dealer, in Saddle River, N.J. “The majority of our customers treat forex as an alternate investment.”

Latest Currency Quotes

These online trading vehicles offer great features: timely trade executions, low capital requirements, tight spreads, order management tools, charting and tutorial services and multilingual resources—attesting to the global expansion of currency speculation. Most importantly, the platforms allow users to borrow money beyond their initial investment, enabling them to make larger bets on the market.

Such leveraging can create capital ratios of anywhere from 20:1 to 400:1. In other words, a $1,000 investment can be turned into a $400,000 currency exposure. Needless to say, the levels of pain or gain are multiplied accordingly.

Rules Of The Game

It is imperative for any investor considering a venture into forex to fully understand the perils and benefits of leverage, and to exercise good risk management and trading discipline. Although margin requirements present a certain safety mechanism, highly leveraged trading remains a risky proposition that can test even seasoned professionals.

In addition to risk management considerations, aspiring forex players should ponder questions of time commitment.

“To extract good value from a market that is open 24 hours a day, five days a week, a certain degree of diligence and dedication is necessary,” says Alan Ruskin, chief international strategist at RBS Greenwich Capital.

Moreover, currency transactions lie at the heart of all global business and capital flows, accounting for the market’s incredible depth and complexity. Successful currency speculation requires constant evaluation of many moving parts, in contrast to the more linear equity investment

Notwithstanding these concerns, how likely is it for individual investors to make money trading currencies?

The answer may appear easier in standard volatility markets—referred to as “normal market conditions” by some online providers—and trending cycles. For instance, in the current bearish dollar environment, selling dollars on rallies should theoretically lead to profits. And often it would, proving the forex traders’ adage that “the trend is your friend.” But things are never quite this simple or easy.

A Very Big Market

Even though currency markets can sustain trends for months—presenting both long-term investors and short-term speculators with optimal trading conditions—sharp reversals can quickly disrupt the markets, as witnessed during the subprime meltdown and the unwinding of the yen carry trade.

During these highly volatile corrective spells, macro trading can become costly to the average speculator with limited means and should give way to short-term opportunistic interventions. Successful forex dealing requires constant revaluation of one’s outlook and targets.

So is an investment in foreign currencies a wise financial move? The answer depends on the investor’s tolerance for risk and degree of commitment.

For most investors, the intrinsic volatility of the currency markets should be a major deterrent. “Due to the nature of the underlying asset, currency markets are highly sensitive to a wide array of factors, such as world events, government policies, and political pressures, to name a few,” says Ruskin. “This adds to their unpredictability.”

For those willing to tolerate the risks but not the labor associated with the currency markets, participation can be achieved to varying degrees through a portfolio of international stocks and bonds or currency mutual funds.

For the few with a large risk appetite and readiness to invest time as well as capital, the unprecedented electronic access to the currency markets presents a rewarding, yet risky, investment alternative. With diligence and discipline, investors can extract good value by treading lightly into forex during “normal market conditions.” However, in periods of turmoil and extreme volatility, currency trading should be left to the professional and the brave at heart.  

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