The Risks of Currency Trading | Mutual fund

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Taking a do-it-yourself approach to currency investing is like trying to run your own plumbing: you might be able to do it, and you just might be able to do it. But that doesn’t mean you should, especially when the chances of causing a leak or flooding your financial base are high.

“For self-directed investors, predicting and attempting to profit from currency fluctuations can be difficult and dangerous,” said Joe Jennings, senior vice president of PNC Wealth Management in Baltimore. “Without the right tools, investing money in strategies to profit from such moves is speculation, not investing.”

That said, the game is proving tempting to some and can eventually be won with some wise advice and a lot of homework, says Chris Gaffney, president of EverBank World Markets and based in St. Louis. “We like to think of currencies as a country’s ‘stock’, and therefore suggest investors look at the underlying fundamentals of the representative country.”

Here are 10 factors to consider when planning to embark on currency investing, also known as forex investing.

Political pieces have a role. As with any international investment, the value of the currency will have some correlation with the internal conditions of a given nation. “Understanding the political, economic and institutional framework in which a given currency trades,” says Werner Bonadurer, clinical professor of finance at the WP Carey School of Business at Arizona State University. This still doesn’t make DIY trading a good idea, but it might tip the knowledge base in your favor.

Central banks take center stage. The monetary policies defined by central banks have a direct correlation with the performance of currencies. “Central banks make the rules and we all cook in their kitchens,” says Lennon Sweeting, corporate reseller at USForex, an international currency payments provider based in Toronto. He cites this real-time example of central banks in action: “The US Federal Reserve is on the verge of tightening monetary policy, while other central banks are loosening their policies and creating an easy money environment. This divergence should see the big [currencies] lose value, while policy tightening in the United States should see the greenback gain. “

A banking superstar can make a difference. Do you remember how much Democrats and Republicans loved former US Federal Reserve Chairman Alan Greenspan? We could compare him to Raghuram Rajan, governor of the Reserve Bank of India. He already had an exceptional track record as chief economist for the International Monetary Fund and professor of finance at the University of Chicago.

“After taking office, Rajan’s strategy was simple: reduce current account deficits, reduce inflation and implement monetary reforms,” Gaffney said. “He’s been a year and a half in his nomination, and the numbers are clearly in his favor. These figures include a drop of more than 30% in the rate of inflation over the past 16 months and huge increases in foreign investment in the first weeks of 2015, which are both strong signs of an economy. and a moving currency.

Try the forex through exchange traded funds. As securities that track a commodity or group of assets, ETFs often prove to be a profitable favorite for self-directed investors. “For those looking to enter the [forex] but I don’t have time for training, I encourage you to use the low leverage of currency ETFs, ”says John O’Donnell, knowledge manager at the Online Trading Academy, based in Irvine, Calif. . “They can invest in a single currency or in a basket of currencies. He adds that currency ETFs can help new traders capitalize on the potential benefits of currency exchange, as they hedge risks through diversification.

Treat currencies like small change. Although a rise in a currency can generate good profits, the sector remains volatile as unpredictable market forces can act like strong winds. “They should represent a small portion of every portfolio because they are almost entirely uncorrelated to the stock, bond and commodity market,” says Jeffrey Sica, president, CEO and chief investment officer of Circle Squared Alternative Investments in Morristown. , New Jersey. What is the wisest percentage? “No more than 10 percent,” he says.

Long haul can be better than average. Financial experts speak of a process known as “mean reversion,” where prices and returns end up reverting to an average. With currencies, this average could increase over time if economic growth increases, but that’s a big “if”. “In the long term, currency movements are expected to revert to the mean, while shorter-term movements can be difficult to exploit,” Jennings said.

Don’t get carried away by short carry trading. Forex traders adopt the carry-trading strategy because it allows them to borrow in a low-yielding currency and invest in a high-yielding currency. “Too many investors fall in love with it and do not sufficiently take into account the risk of” short ” [or the borrowing] currency to appreciate over time, ”explains Bonadurer. “As someone said, ‘Carry trading is like collecting pennies in front of a steamroller.’ You will be hit at some point.

Speed ​​is not what you need. Trying to beat ripples in a currency over a period of hours or days is particularly dangerous. “The forex market is moving very quickly,” says Lance Roberts, editor of Streettalklive.com and chief economist, strategist and partner at STA Wealth Management in Houston. “Unless you’re sitting in front of a screen and watching it tick by tick, you could make an investment and be deep in the red an hour later.”

Leave your emotions at the door. Rooting for a favorite currency against all logic or evidence and hoping for a comeback is a lot like rooting for the Chicago Cubs. “The behavioral biases and emotions of investors cloud their judgment and lead them to lose money in the forex market,” says Robert Johnson, president and CEO of the American College for Financial Services at Bryn Mawr, in Pennsylvania. “More specifically, a currency investor will take a stand and see that the market moves against them. They have a loss, but don’t want to close it because they will have to admit they made a mistake. Such investors are in the throes of “fixing”.

Big boys can fail too. For decades, FX Concepts of New York City has reigned as the undisputed king of forex hedge funds. Yet, after managing over $ 14 billion in 2007, FX Concepts went bankrupt in October 2013, largely due to the devaluation of their currencies by central banks. So the fund, which once had three dozen employees in information technology and research, as well as statistical gurus, found that its proprietary currency models no longer worked. It’s hard to say which may have collapsed first: forex investments or FX computers.

The currency game is a game you can win, but be prepared to hang onto it for the long haul. Sica predicted in an article published in January by US News, “10 investments for the big players”, that the dollar would strengthen against the euro, which came true with the announcement on Tuesday that the euro had hit $ 1.08, its lowest level in more than a decade. But Sica adds that he had been waiting for such a result for almost four years.


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