Television commercials, online ads, email blasts and pitchmen of all kinds extol the financial benefits of investing in currencies – known as foreign exchange. When presented with such awesome opportunities to make vast sums of money, it’s easy to be tempted.
However, forex markets are the playground of the ultimate institutional big dogs.
Currency pairs trade against each other as huge government and financial funds buy and sell currencies to balance or hedge their institutional currency exposures.
The forex market is a 24-hour, rapidly changing marketplace that challenges even the pros, and investment returns in currency trading can range from significant losses to significant profits.
Currency Funds in Comparison
The best way to view your chances of making money on currency investing is to look at the professionals. Consider the returns on the top-performing currency mutual funds, as reported in March, 2013 when the Dow Jones Industrial Average was making new historical highs: Morningstar lists currency funds with consistent top performance as reporting losses of 1.14 percent, up to gains of 1.13 percent return on investment over the previous three months.
Trading success can be as much to with following trading and market timing strategies as to individual skill.
Over five years, the highest annualized gain reported was 3.84 percent. These do not represent huge profits unless you are investing huge capital and using leverage.
In fact, if you had invested $12,000 in a top quality intermediate bond fund in March 2008, your investment would probably be worth more than $16,000 in March 2013. That is an annualized total return of over 6.5 percent in a top-rated, relatively low-risk investment.
If in March, 2009, you had invested in a fund that tracks the Dow Jones, at its March 2013 high you might have achieved a return of greater than 100 percent.
Trading Currencies – “The Pros”
The Bank for International Settlements (BIS) did an exhaustive study of professional currency managers, their methods and performance over time. Among other things, the study concluded :
“While we find that many individual managers have unique skills that result in outperformance over simple beta strategies, some of it could be due to luck.“
The study (see here) also concluded that profits were the result of currency market volatility, global interest rate volatility, and taking advantage of currency market anomalies.
Trading volume from retail investment accounts grew to a daily volume of $125 billion in 2010 from $10 billion in 2001
Trading success was attributed as much to following trading and market timing strategies as it was to the individual style of the professional trader — of course, not all professional traders were profitable.
Risky and Volatile
The U.S. Commodity Futures Trading Commission warns that individual investors should be wary of claims that portray forex trading as easy and profitable (see the full report). In terms of dollar volume, forex markets are among the largest trading markets and are extremely active.
They are also dominated by professional traders at big banks, corporations and government funds but, unlike the stock and bond markets, they are not traded on an exchange, so investors do not have the protection provided by exchange rules, arbitration and clearing houses.
Nevertheless, trading volume from retail investment accounts grew to a daily volume of $125 billion in 2010 from $10 billion in 2001. Although continuing to grow, retail currency trading still accounts for less than 5 percent of global currency trading volume.
Consider alternatives to directly investing in currencies if you don’t feel you can compete against professional currency traders, or want to maintain your portfolio vigilance 24 hours a day, every day.
Keeping a portion of your assets in currencies as a way to hedge your portfolio can be done through investments in professionally managed mutual funds, exchange traded funds or exchange traded notes issued by banks. If you own mutual funds that invest in foreign securities, your portfolio is already involved in currency-influenced investments.