By Thomas Kostigen
The largest and most liquid market in the world is money. More than $5 trillion per day is traded via the world’s currency markets, or foreign exchange market, as it’s called under one umbrella. Yet, while trading volume is massive, participation by individual investors is minimal—less than 10 percent of all currency trades are made by retail investors, according to a number of reports. Institutional investors like banks, brokerages, and hedge funds are the biggest buyers and sellers of currencies. Often, these trades are executed to hedge against risk of holding assets in any one denomination.
If an entire portfolio is denominated in US dollars, and the price of the US dollar sinks relative to other currencies, then the global value of that portfolio sinks. By swapping US dollars into other currencies, asset managers can lessen the risk of losing value.
Currencies fluctuate for numerous reasons — political reasons, military reasons, manufacturing output, economic statistics, or sheer rumors, can send the value of a currency lower. Take Brexit. The fear that the United Kingdom would suffer from disassociating with the European Union has impacted the value of the pound, which has lost some 20 percent of its value since the UK voted to leave the EU in 2016. Big investors believe the UK economy would weaken, and that sent the pound tumbling.
Essentially, a country’s currency represents a belief in how strong it is; when its vulnerable, investors move funds to safer havens. And that cheapens that country’s currency value.
To be sure, there is a lot of upside to investing in the forex market. Because investors can leverage their positions, effectively borrowing money at a 50-to-1 rate (and sometimes more), they can reap huge returns on investment. This potential is what many late-night television informercials seize on to hook individuals into forex trading programs. But while profits can be sky high, the risk of losses is equally large. It all goes back to the complexities of the forex market, and all the factors that can weigh on a currency. If the price of oil rises, employment figures dip, or other issues arise — especially suddenly — that portend a stall in growth, currency prices can change dramatically. Which is why the majority of retail currency investors lose money. Interestingly, the vast majority — 84 percent of retail investors — think they can make money in the forex market, according to a Citibank survey.
Financial advisors may be able to set the record straight for individuals who see great riches to be had in the forex market. Advisors are uniquely qualified to tell people that when something seems too good to be true, it usually is.
That doesn’t mean forex investing doesn’t have its place in a portfolio. In fact, there are numerous mutual funds and exchange traded funds that center on currency trading. And, for the brave, individual trading accounts can be designed. Higher net worth individuals can invest in a currency hedge fund.
Technology has allowed investors take a truly global view of investing. It also has created efficiencies in trading among different currencies. This has, no doubt, led to a rise in interest and volume of forex trading among individual investors. In our next column, we’ll take a look at some of the hot spots in the global currency markets.
Thomas Kostigen is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Thomas is a best-selling author and longtime journalist who writes about environmental, social, and governance issues.