Forex for Everybody?

[This Thursday Re-Run first appeared November 18, 2009.]

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.

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