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 Probus - Forex: foe or friend
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Forex: foe or friend

by Ben Power | 14 Nov 2012

Foreign exchange trading can be a lucrative way to grow your wealth, but you must be aware of the risks.

The Australian dollar has become a ‘risk currency’, trading as high as 110 cents and as low as 94 cents against the US dollar during the 2011/2012 financial year. “Whenever traders feel like taking a risk or being bullish, they turn to the Australian dollar,” says Phil Horner, a trading analyst at AxiTrader. “And if they’re not feeling confident, then they sell the ‘Aussie’.”

Investors are increasingly being lured by the action and volatility of foreign exchange (forex) markets. “People are tired of the share market,” says Horner. “It’s not going anywhere.”

A raft of brokers and educators are also heavily promoting the benefits of forex trading, such as the ability to make money in rising and falling markets, the large number of markets on offer, volatility, and the ability to use huge leverage.

But this doesn’t necessarily mean forex trading is a suitable asset investment for retirees primarily focused on funding their retirements. While there are opportunities, there are also pitfalls. Those looking to enter the high-stakes world of forex need to educate themselves fully, pick the right markets and, above all, be mindful of the risks of leverage. “Retirees entering this market without doing their research or understanding what they were doing would be taking massive risks,” says Alex Douglas, managing director at Interbank FX Australia.

Knowing the market

Foreign exchange is the largest and most liquid financial market in the world, with an annual turnover of four trillion dollars.

Currencies are traded and priced against each other in pairs; the most common and widely quoted pair is the Australian dollar against the US dollar (AUD/USD). Forex traders can access roughly 20 or 30 currency pairs, depending on their brokers. “The ones you want to stick to are called the ‘majors’,” Douglas says. In addition to the AUD/USD, the majors include the euro against the US dollar (EUR/USD), the US dollar against the Japanese yen (USD/YEN), the US dollar against the Swiss franc (USD/CHF), and the British pound against the US dollar (GBP/USD).

Investors have access to a growing number of online platforms tailored to retail traders, and they need to shop around to find the best.

Douglas says the key is to find a broker platform that is reliable and will not crash all the time.

An investor also needs a strategy to guide their buy and sell decisions. Most strategies fall into one of two broad categories: fundamental analysis or technical analysis.

With fundamental analysis of forex markets, a trader buys and sells based on macroeconomic and social factors, such as government fiscal policies and the levels of trade and political stability.

With technical analysis, a trader buys and sells based on trends and indicators by examining charts and how currencies have fared in the past. “Technical analysis is fairly heavily represented when it comes to forex trading,” Douglas says.

One of the best ways investors can develop and hone forex trading strategies that suit both their goals and personalities is through a ‘demo’ account. Demo accounts behave exactly like real accounts, but use pretend money so you don’t actually risk anything.

Beware the risks

Trading in currency can be highly lucrative but also extremely risky. The biggest danger is the use of leverage. Most transactions involving foreign currencies will require you to put down a margin. This will usually be only one or two percentage points of the value of what you have ‘bought’ or ‘sold’. So if you have $1000, you can trade up to $100,000. When you close the trade, the $1000 will be returned to you, plus or minus the change in value of the $100,000.

Leverage is a double-edge sword. It gives you the ability to make huge profits, but can also wipe out your account.

Prospective traders must remember that successful profit making is achieved through small incremental wins and that only a minor amount of one’s savings, particularly for retirees, should be dedicated to it.

Glossary

Foreign exchange swaps: the purchase and sale of identical amounts of two currencies – although they have different value dates.

Contracts for difference: a contract between a buyer and seller that specifies the buyer will pay the seller the difference between an asset’s current value and its value at contract time. However, if the difference is negative, the seller pays the buyer instead.

Spot trading: an agreement between a buyer and seller to trade currencies at an agreed price for settlement on the spot date, which is normally two days after the trade date.

Options: a contract which specifies that a buyer can purchase an asset in the future with a reference price set. The buyer does not have to purchase the asset, but the seller must comply if they do. The price of the transaction will be the difference between the reference price and the value of the asset.

Forwards: an agreement to purchase an asset at a future date, with the price set at the time of the agreement.

> Foreign exchange trading can be a lucrative way to grow your wealth, but you must be aware of the risks.

 

The Australian dollar has become a ‘risk currency’, trading as high as 110 cents and as low as 94 cents against the US dollar during the 2011/2012 financial year. “Whenever traders feel like taking a risk or being bullish, they turn to the Australian dollar,” says Phil Horner, a trading analyst at AxiTrader. “And if they’re not feeling confident, then they sell the ‘Aussie’.”

 

Investors are increasingly being lured by the action and volatility of foreign exchange (forex) markets. “People are tired of the share market,” says Horner. “It’s not going anywhere.”

 

A raft of brokers and educators are also heavily promoting the benefits of forex trading, such as the ability to make money in rising and falling markets, the large number of markets on offer, volatility, and the ability to use huge leverage.

 

But this doesn’t necessarily mean forex trading is a suitable asset investment for retirees primarily focused on funding their retirements. While there are opportunities, there are also pitfalls. Those looking to enter the high-stakes world of forex need to educate themselves fully, pick the right markets and, above all, be mindful of the risks of leverage. “Retirees entering this market without doing their research or understanding what they were doing would be taking massive risks,” says Alex Douglas, managing director at Interbank FX Australia.

 

Knowing the market

Foreign exchange is the largest and most liquid financial market in the world, with an annual turnover of four trillion dollars.

 

Currencies are traded and priced against each other in pairs; the most common and widely quoted pair is the Australian dollar against the US dollar (AUD/USD). Forex traders can access roughly 20 or 30 currency pairs, depending on their brokers. “The ones you want to stick to are called the ‘majors’,” Douglas says. In addition to the AUD/USD, the majors include the euro against the US dollar (EUR/USD), the US dollar against the Japanese yen (USD/YEN), the US dollar against the Swiss franc (USD/CHF), and the British pound against the US dollar (GBP/USD).

 

Investors have access to a growing number of online platforms tailored to retail traders, and they need to shop around to find the best.

 

Douglas says the key is to find a broker platform that is reliable and will not crash all the time.

 

An investor also needs a strategy to guide their buy and sell decisions. Most strategies fall into one of two broad categories: fundamental analysis or technical analysis.

 

With fundamental analysis of forex markets, a trader buys and sells based on macroeconomic and social factors, such as government fiscal policies and the levels of trade and political stability.

 

With technical analysis, a trader buys and sells based on trends and indicators by examining charts and how currencies have fared in the past. “Technical analysis is fairly heavily represented when it comes to forex trading,” Douglas says.

 

One of the best ways investors can develop and hone forex trading strategies that suit both their goals and personalities is through a ‘demo’ account. Demo accounts behave exactly like real accounts, but use pretend money so you don’t actually risk anything.

 

Beware the risks

Trading in currency can be highly lucrative but also extremely risky. The biggest danger is the use of leverage. Most transactions involving foreign currencies will require you to put down a margin. This will usually be only one or two percentage points of the value of what you have ‘bought’ or ‘sold’. So if you have $1000, you can trade up to $100,000. When you close the trade, the $1000 will be returned to you, plus or minus the change in value of the $100,000.

 

Leverage is a double-edge sword. It gives you the ability to make huge profits, but can also wipe out your account.

 

Prospective traders must remember that successful profit making is achieved through small incremental wins and that only a minor amount of one’s savings, particularly for retirees, should be dedicated to it.

 

 

Glossary

Foreign exchange swaps: the purchase and sale of identical amounts of two currencies – although they have different value dates.

Contracts for difference: a contract between a buyer and seller that specifies the buyer will pay the seller the difference between an asset’s current value and its value at contract time. However, if the difference is negative, the seller pays the buyer instead.

Spot trading: an agreement between a buyer and seller to trade currencies at an agreed price for settlement on the spot date, which is normally two days after the trade date.

Options: a contract which specifies that a buyer can purchase an asset in the future with a reference price set. The buyer does not have to purchase the asset, but the seller must comply if they do. The price of the transaction will be the difference between the reference price and the value of the asset.

Forwards: an agreement to purchase an asset at a future date, with the price set at the time of the agreement.