Sometimes sticking to stocks and bonds just isn’t enough for the investor that wants to make his portfolio a little more exotic.
For the aspiring speculator, a wide range of options are available: trading options, trading on margin, owning precious metals, and FOREX trading.
Be forewarned: you should never dedicate more than 5-10% of your nest egg to any kind of speculative trade opportunity whether it be picking individual stocks on your own or doing currency trading. You can survive losing that small chunk of your portfolio, but not a significant portion of your assets.
What is FOREX Trading?
FOREX trading is short for foreign exchange.
It is the process of trading two different currencies. You are trading — or exchanging — one currency that you sell and buying another currency.
Trading FOREX usually happens in major currencies like the US Dollar, Japanese Yen, and the Euro. The currencies are traded in pairs that are read with the currency you are buying in the numerator and the currency you are selling in the denominator.
For example, let’s assume you believe the Euro will increase in value in comparison to the US Dollar.
You want to buy Euros and sell Dollars. The FOREX pair you would receive a quote on is EUR/USD. The quote comes back as 1.3200. This means that it would take 1.3200 Dollars to buy 1 Euro. If you traded $100 USD you would get €75.75 back. (This is also called “being long” in Euros.)
You are hoping that over time the Euro will appreciate over the dollar and you’ll be able to trade your €75.75 back into USD for more than $100. At some point in the future you run your quote for EUR/USD again and it comes back 1.400. This means the Euro’s value has appreciated and the Dollar’s value has depreciated. If you were long Euro, you could now trade back that €75.75 into $106.05.
Why Trade FOREX?
Although some companies will trade in FOREX to offset some currency risk in their overseas operations, a large majority of FOREX trades are done on a speculative basis by individuals for profit.
One reason speculators are drawn to foreign exchange trading is the marketplace operates 24 hours per day for all but a few days during the week. Your normal stock exchanges are only open for a certain number of regular business hours each day during the week.
FOREX trading, on the other hand, begins trading about 5pm Eastern in Australia and ends at 2am Eastern, Toyko starts at 7pm and ends at 4am Eastern, then New York is open from 8am to 5pm, and lastly London is open from 3am to 12pm Eastern. You could begin trading at 5pm Eastern in Australia on Sunday evening and continue trading until Friday evening at 5pm in New York.
Many speculators also believe they can predict which currencies will outperform others.
If you believe the American economy is going to improve while the European economy is dragged down by debt problems, you might go long on USD in order to profit from the global economic news.
How does FOREX Trading Fit In My Portfolio?
FOREX isn’t for the faint of heart as currencies can appreciate and depreciate quickly based on economic news elsewhere in the world. But if you limit your losses to only a sliver of your portfolio, you can dabble in it without causing too much damage.
FOREX belongs in the category of your portfolio with all of the other speculative investments like precious metals and futures. With the trading markets being open for 24 hours per day from Sunday evening to Friday evening, you can be asleep when major economic news hits the markets and ruins your trade.
It is wise to set limits up ahead of time so that you can limit your losses if something major happens while you are sleeping.
You Don’t Own Anything
An interesting aspect of FOREX trading is you aren’t buying shares in anything. With individual stocks you are being granted a percentage of ownership of a business. You might be entitled to dividends as part of that business, and you could hold your shares your entire life while they appreciate.
With trading currencies, you don’t own a share of anything. There are no dividends to be had.
You are betting that one currency will outperform the other — it’s a bet on the direction a currency’s value will go rather than owning anything.
Final Thoughts on FOREX
Trading foreign currencies against each other is a sophisticated version of betting on the global economy.
You can certainly earn a profit by betting in the right direction, but you can just as easily be wrong as you are right. With the lack of any sort of income potential like dividends in stocks, you can only profit by your trade going the right direction.
You don’t have a claim of ownership to a business and must rely on trading for profits. That means you will be paying a lot of trading fees in order to keep your profit moving, which makes FOREX trading a far better deal for the brokers that execute the trades than the average speculator that tries to profit on his own.