Introducing Forex Investing
The value of most major currencies in the world is constantly changing due to economic conditions, interest rates, politics and other factors. The worldwide nature of these assets means there is always some way to get involved in the market. Most small investors generally get involved by holding foreign currency (e.g. British pounds, Euros, Swiss Francs or Japanese Yen) in their brokerage account as cash. Alternately, you can open an account at a foreign bank in Canada, the UK or another country. The traditional goal of Forex investing is to buy a foreign currency (e.g. 100 Swiss Francs) and closely monitor changes against your home currency (e.g. the US Dollar), making a trade when the rate is attractive. Compared to other investment approaches such as mutual funds, Forex has many risks to consider.
To properly understand the disadvantages of foreign exchange (also known as "Forex") investing, consider how this market works and how it compares to other types of investment activities. Before getting involved in foreign currencies, even if you have a strong background in economics and statistics, understanding the impact of all the factors impacting foreign currencies is extremely difficult. Large companies and investment banks have departments dedicated to foreign exchange given the complexity of this asset. Unlike your local stock market, Forex trading happens constantly. The prospect of easy profits has also given rise to numerous Forex investing scams – an additional risk investors have to educate themselves about in this area.
The sheer size of the Forex market is another challenge small investors will meet in this market. According to Barry W. Ickes at Pennsylvania State University, the foreign exchange market is much larger than the world's GNP and even world trade. On a daily basis, the trading volumes in foreign exchange exceeds $1 trillion US dollars in value. It is estimated that a majority of currency trading involves a handful of currencies: the US dollar, the Japanese Yen and the Euro. Seeking a gain in these large markets will be challenging as you will not have the same capital and resources available as large banks and firms. While large players are at work in every aspect of the investing world, their role is even stronger here.
Unlike stock prices and other types of financial assets, the foreign exchange market is also heavily impacted by politics. The political aspect of foreign exchange investing makes this market more difficult to predict. From time to time, central banks around the world intervene in the markets to change the value of their currencies – even if these interventions change the value of a currency only slightly, this can quickly overcome your trading strategy. For investors that are using US dollars (e.g. US dollars / Yen, US Dollars / British Pounds, etc.), there are additional problems. As the world's reserve currency, many investors, banks and others move their investments to US dollars in times of uncertainty and crisis. This special status of the US dollar can make it difficult to make sustained gains in Forex trading.
Foreign Assets In Your Portfolio
Now that you understand why Forex is a bad investment, you may still want to have some foreign content in your investment portfolio. If you do not want to hold foreign currencies directly, there are several viable methods of investing internationally. For those confident in their day trading abilities, you can buy shares in foreign stock markets in Europe, Canada, Australia, Japan and other locations. Not all brokers make it easy to buy and sell foreign stocks, however. Fortunately, there are other ways of investing internationally. You can use mutual funds and exchange traded funds (ETFs) that contain foreign stocks and bonds. Let's explore this option in further detail.
Many financial advisors suggest investors should have between five to ten percent of their assets in international investments. However, investing directly in foreign stocks can be difficult when you can't read the company's annual reports or other publications. The best way for small investors to get foreign content in their portfolio is to use a mutual fund or ETF with a low (under one percent) fee. To aid in your research, you may want to learn more about some of the world's common stock market indexes. For example, if you wanted to invest in the British stock market, look for a product that tracks the FTSE 100 index. In contrast, if you were looking to invest in Canada, consider a product that tracks the TSX300 or the TSX 60. These indexes typically focus on large, established companies that have been profitable for many years. For investors seeking security, you can also look for bond funds that contain bonds from foreign companies and governments. Keep in mind not all governments around the world have a strong history of paying bonds so you will need to do some additional research to better understand the risks involved in foreign bonds.
- Barry W. Ickes, The Foreign Exchange Market, http://econ.la.psu.edu/~bickes/forex.pdf
- Image Credit: Tomasz Sienicki Forex/Wikimedia Commons, used under CC 3.0
- Image Credit: jrkester, A Fistful of Yen, Flickr, used under CC BY-NC-SA 2.0
- Commodity Futures Trading Commission, BEWARE OF FOREIGN CURRENCY TRADING FRAUDS, http://www.cftc.gov/opa/enf98/opaforexa15.htm