The following is the seventh of a series of weekly articles in which Sheryl will provide overviews of investment options that offer alternatives to bank accounts. Last week's article covered commodities. As with any investment that's not an insured deposit account, there are risks.
Just saying foreign currency markets sounds sexy, sophisticated. It’s a different world from stocks and bonds for sure.
Allen Gillespie, chief investment office for FinTrust Investment Advisors works with individuals and institutions, both as an investment advisor and in a brokerage capacity. His firm can facilitate foreign exchange trades in over 25 currencies, including precious metals. Gillespie also serves on the board of a $29 billion pension plan that invests globally, "Foreign currency risk is something we measure and discuss on a regular basis," he says.
The currency market is the largest market in the world with over $4 trillion in transactions done every day, says Casey Stubbs, founder of Winners Edge Trading. "Forex trading has created many wealthy traders with the most being George Soros who made over $1 billion on a trade," says Stubbs.
What’s the big advantage of foreign currencies? "You’re hedging domestic inflation and political risk and building a portfolio more reflective of the global business world," says Gillespie.
The currency market is open 24 hours a day, six days a week. "The market is always open somewhere, which is great for many traders because it fits into their schedules," says Stubbs.
How does the market work?
Currencies are traded in pairs. You always trade one versus the other. For example, you buy the Euro versus the dollar, which is the most traded currency pair in the world, says Stubbs.
Markets move based on economies’ performance. The better the economy is, the better the currency will perform. "Pay attention to economic news," says Stubbs.
Trading currency is done through a Forex retail broker. Every trader must get a broker account, says Stubbs. There are numerous ways to access the foreign currency markets, through cash markets, futures, foreign bonds, exchange-traded funds and mutual funds. "The appropriate choice depends on your circumstances and goals," says Gillespie.
The Forex trader seeks a profit from disparities between a country or group of countries’ economic standing. The best example, is the dollar versus the Euro, says Peter Frawley, vice president-investment and a financial consultant with CoreCap Investments.
"Recently we have watched the dollar climb against the Euro, which means the Euro falls in value. This is where Forex traders seek to reap their profit," he explains. "As we currently stand, the United States is the cleanest dirty shirt in the drawer and the countries that make up the EuroZone are facing various issues," says Frawley. Therefore, the dollar is stronger and the Euro becomes weaker.
If you decide to play the game…
Think through your goals, what do you want to achieve by investing in foreign currencies?
"Don’t be greedy, where you are holding a foreign currency to gain more and more profit. Once you have achieved your goal, make the decision," says Alishan Patel, owner of Boilerroomtrader.com, an online game designed to help you improve your stock trading skills.
Just like with all investments, diversity matters. ""Don’t put all your money in one basket," says Patel.
Chris Martenson, co-founder of PeakProsperity.com agrees. "You need variety with currencies. There’s no way I would keep all my money in the Japanese Yen. The Central Bank has said it will devalue the Yen."
He practices what he preaches. He has British pounds, Euros, Canadian dollars and gold. Why those? "I chose this group because it feels like there is a chance that one or more of these will perform better than other types of currencies." Even still, he only dabbles with foreign currencies --- they make up about 2% of his portfolio.
Think about how much and where people want to do business when deciding which currencies to invest in, says Gillespie. Assess whether the amount of business being conducted there is increasing or decreasing.
Invest in currencies where the corresponding currency country is not under a lot of debt, as that precedes high inflation and hence, confidence in those currencies decline over time, says Patel.
Be patient. "You need patience to see results. If you are not a person with a lot of patience, then do not invest," says Patel.
Understand the risks
Political, economic and interest rate risk all affect currency trading, and can do so when the currency investor is soundly, or not so soundly sleeping.
Currencies, in and of themselves have no absolute value, just a relative value, unlike a bond, stock, or piece of real estate that has a future stream of cash flows attached to it, says Gillespie.
Of much importance, in the foreign exchange trading markets there can be significant volatility. "Most recently, the Swiss Franc removed their peg against the Euro. Shortly thereafter, the Franc jumped 30% in value. Another example is the current environment in Russia. Due to the Ukraine and the fall in the value of oil, the ruble has dropped in value by over 40%," says Frawley.
Simply put, "Foreign currency is speculating, not investing. Currencies are moved by big players. I don’t recommend getting involved with foreign currencies unless you are okay with losing money, you’re gambling," says Martenson.
Currency trading is best left to the sophisticated investor, such as corporations who need to hedge against currency risk for their overseas operations, and institutional investors who seek higher diversification beyond common asset allocations, says Frawley.
He says recently an online foreign exchange market broker, FXCM, nearly went bankrupt because they allowed retail (the average Joe and Jane), as well as institutional investors speculate on global foreign exchange markets in a manner that allowed the investor to leverage his account by going on "margin" – trading with less than the full value of the currencies in your hand, even though you owe the full amount when you’re speculating on a trade between currencies. "It works very well when your trade is a profit, but can wipe you out if your trade goes south," says Frawley. He says FXCM needed a loan of $300 million to prevent its bankruptcy.
The market is also less regulated than other financial markets, points out Gillespie.
Keep in mind, says Martenson, "Currencies’ movements depend on things you can’t predict or control."
Editor's Note: To review more options for investing in foreign currencies, please refer to the DepositAccounts.com article, "Pros and Cons of Foreign Currency CDs and Bank Accounts".