Forex for Everybody?

Last week Moolanomy ran a long post on Forex Trading Basics and How It Works. Although reasonably factual, the post qualifies as bad money advice Chicklet-currency for strongly implying that there is a possibility that investing in forex might be a good idea. It also ends with a paid link to a forex broker-dealer.

Forex, if you don’t know, is trading in currencies, also known as foreign exchange. And if you didn’t know that, I’m sorry I told you. You could have probably lived happily ever after without knowing that this particular intersection of investing and gambling existed. Oh well. Too late now.

Superficially, currency markets are simple. A person might buy some Japanese Yen, for example, in the hopes that it would go up in price relative to the dollar. If it does, it can be sold for a profit, if it goes down, for a loss.

Two things make this more casino-like than most financial markets. First, currencies trade very actively, literally 24 hours a day, so whatever the time of day or night there is some action to be had. Second, for reasons that are hard to explain, the margin requirements are tiny. 100 to 1 is relatively ordinary, meaning that you can buy $1,000,000 worth of Euros with $10,000 down and $990,000 borrowed. If the Euro goes up 1% you double your money. If it goes down 1% you’re wiped out. What fun!

Problem is that unless you are the kind of person who knows the names of the men in charge of the major central banks of the world, you are unlikely to have any kind of edge in this game. I’ve got a variety of financial credentials and years of experience running global (multi-currency) equity funds and I would never dream of trying to make money here. Seriously, on-line Texas Hold ‘Em is more exciting and more likely to result in profit.

I’ve several times repeated my advice on investing in individual stocks: do it if you enjoy it, but don’t expect to do better than index funds over the long haul. And, relative to forex, the stock market is a comparatively easy place for an amateur to make money. Pricing is transparent and stocks move mostly based on news that is widely available and generally understandable.  There are also elaborate regulations and occasionally even regulators to make it harder for you to do foolish things.

Forex is one of several non-mainstream investments that occasionally spark the interest of those who should know enough to stay away. Commodities, including precious metals, and collectibles, running from fine art to baseball cards, are other examples. And they all have basically the same problem. You are competing, and trading, with people who do this for a living. Not only do they know more about it, they are probably rather good at it, because if they weren’t they couldn’t make a living.

42 Comments

  • By CalLadyQED, November 18, 2009 @ 4:40 pm

    I already knew about Forex, but I thougth money market accounts and funds were related to it. That is, I had thought that “money market” = “foreign currency market.” (Doesn’t currency = money, after all?)

    Anyway, your post prompted me to look up money market funds and, lo and behold, the money market is, according to Wikipedia, “the global financial market for short-term borrowing and lending.” Learn something new every day. :)

  • By Jim, November 18, 2009 @ 4:53 pm

    Seems to me that simply buying foreign equities or bonds would be a much better way to invest outside the US and/or bet on or hedge against currency changes.

  • By Dan, November 18, 2009 @ 6:45 pm

    Ok, I get why betting against the French Polynesian Franc (or even the Thai Bhat) can be an iffy proposition, but…

    Isn’t trading against the Euro and Pound much less so? (They’d be the only currencies I’m tempted to trade against.) With the $787B stimulus package floating around, “everybody knows” the dollar is going to be devalued, so why is it wrong to “bet” accordingly?

  • By Jim, November 18, 2009 @ 8:07 pm

    Dan, If “everyone knows” that the dollar is going down then the market will account for that and trading rates have that built into it. So theres no ‘edge’ or benefit in the trade by knowing what “everyone” knows. Unless you’ve got special knowledge then you’re at a disadvantage to the pros.

  • By ParkerBohn, November 19, 2009 @ 7:57 am

    Forex is a zero-sum game. Much like poker, there is a dollar lost for every dollar gained. So you better be sure you have an edge if you want to play this game.

    The stock market is a positive-sum game. It is possible for us all to win as the economy grows and dividends roll in.

  • By Larry, November 19, 2009 @ 9:29 am

    Frank: “Forex is one of several non-mainstream investments that occasionally spark the interest of those who should know enough to stay away. Commodities, including precious metals, and collectibles, running from fine art to baseball cards, are other examples.”

    Forex is a game I would never play. But can all these other investments be lumped together in the same boat? I know a little about the fine-art market,* but what about precious metals? Would people care to venture an opinion about, say, putting 2-3% of one’s portfolio into something like the Vanguard Precious Metals Fund?

    *In a nutshell: any art of truly serious investment quality is going to be unavailable to the average collector, because there’s a heavy demand from wealthy purchasers and art dealers control the supply. However, relatively inexpensive pieces by emerging artists are easily available in galleries all over the country and Europe; I myself work with about 4-5 art dealers in Chelsea and Williamsburg and have built a modest collection of some very nice pieces, in some cases for as little as $200-500 each. Genuine 19th-century Japanese prints of good quality are also plentiful in this price range, for example.

    But one should never fool one’s self into thinking that art is an “investment” at this level; it is more something you buy for its aesthetic qualities and your desire to support the artist. If the value of such art goes up, well and good, but there’s no guarantee, and if you’re buying from a dealer, typically 50% of the purchase price is the dealer’s commission.

    At least if you buy from a reputable dealer, however, you are certain to acquire bona fide original work; the other key danger to avoid with art is buying fakes – whether they’re phony Salvador Dalis or Picassos, oriental rugs, African masks, or whatever. Lots of would-be “investors” have been burned by buying fake knock-offs at pretty prices from dishonest dealers.

  • By Craig, November 19, 2009 @ 10:48 am

    On the whole, I only invest in vehicles that are win-win: stocks, bonds, that sort of boring stuff. I thrive if–and because–my counterparties thrive. Or at least that’s the ideal. Very Norman Rockwell.

    Investments where one party has to lose for another to win–commodities, currencies, derivatives of all kinds, really–are basically poker games. And if you’re sitting at a poker table, and you don’t know who the sucker is….well, it’s you.

  • By Dan, November 19, 2009 @ 12:33 pm

    Jim, I’m not a believer in the efficient market hypothesis. If it were, we’d never have bubbles.

    That said, even if “everybody” knows something general about the movement of market X (be it the dollar, the stock market, or precious medals) nobody knows the magnitude of said movement.

    For example, when the Dow was at 6500, I figured it was an excellent time to buy (although just finishing grad school, didn’t have anything to invest at that moment.) Even if “everybody knows” the market is undervalued at that point, nobody knows by how much, so how can you accurately price it?

  • By Dan, November 19, 2009 @ 12:36 pm

    One other thing… people talk about the “pros” as if they’re actually good at what they do. Who here in their right mind thought that buying mortgage backed securities that originated from sub-prime borrowers obtaining option-ARMs was a smart thing to do?

  • By Jim, November 19, 2009 @ 3:44 pm

    “nobody knows the magnitude of said movement” & “so how can you accurately price it?”

    Two good reasons not to bet on currency movements.

  • By Patrick, November 19, 2009 @ 5:17 pm

    @Dan: if you’re not a believer in the efficient market hypothesis, how do you explain why people with billions of dollars at their disposal haven’t arbitraged away the supposedly obvious opportunities you’re seeing?

  • By Mike Piper, November 22, 2009 @ 4:12 pm

    I know this is a few days after the conversation, but volatility in markets (bubbles included) doesn’t necessarily preclude market efficiency.

    Here’s an interesting video on the topic:

    http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html

  • By stock market invest, January 25, 2011 @ 3:14 pm

    I used to visit Forex for some times. Dollar is now degrading. I guess I will lose money if I will invest on this.

    Cheers,

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