Sophisticated investors have increasingly taken a closer look at the forex market.
By YH Wong
Yogi Berra said, “It is hard to make predictions, especially about the future”.
In the many years that I have followed the global markets, I have found no one, including myself, can accurately predict future prices, the direction of the market, or anything else that has to do with human action. This leads me to the foreign exchange market.
In 1971, President Richard Nixon took the US off the gold standard and the era of floating exchange rates was born. Since then, the foreign exchange market (also known as the forex market) has become the single largest financial market in the world.
Today, it is the most liquid market in the world with an average daily trading volume exceeding US$5 trillion.
How it works
What are forex rates? Foreign currency exchange rates are what it costs to exchange one country’s currency for another. For example, if you go to England on vacation, you will have to pay your expenses in British pounds.
Since your money is all in Ringgit Malaysia, you will have to use (sell) some of your Ringgits to buy British pounds.
The forex market is an international over-the-counter market (OTC). It means that it is a decentralised, self-regulated market with no central exchange or clearing house, unlike stocks and futures markets.
The main players in the forex market with varying needs and interests are governments and central banks, financial institutions, corporations, investors and traders.
Equities and bonds are commonly favoured over currencies in the investment world. Traditional investors only have indirect forex exposure through assets denominated in currencies other than their own.
However, over the years, sophisticated people have increasingly taken a closer look at the forex market as a potential source of compelling investment opportunities.
In the forex market, there is always a winner on the other side of a loser’s trade. Forex prices are influenced by a multitude of different factors, from international trade or investment flows to economic or political conditions.
Donald Trump’s victory in November last year has been a “game-changer” for the global markets especially the forex market.
Rather than the benign Fed outlook that was expected under a Clinton administration, markets are now pricing in a more hawkish Fed due to expectations of significant fiscal stimulus and higher inflation under a Trump administration.
Higher interest rates in the US in the coming months will likely have an impact on the US dollar and other currencies.
Speculators try to take advantage of even small fluctuations in exchange rates. Your neighbour is probably aware that George Soros is one of the most famous currency speculators.
The billionaire hedge fund manager is most famous for speculating on the decline of the British pound, a move that earned over £1 billion in 1992.
Investing in forex
Forex is a leveraged (margined) product, which means that you are only required to deposit a small percentage of the full value of your position to place a forex trade.
This means that the potential for profit, or loss, from an initial capital outlay is significantly higher than in traditional trading.
The fact that you need to go to bed or a fishing trip with your family does not stop the forex markets from operating. Forex markets are open 24-hours a day from Sunday evening through to Friday night.
Trading follows the clock, opening on Monday morning in Wellington, New Zealand, progressing to Asian trade spearheaded out of Tokyo and Singapore, before moving to London and closing on Friday evening in New York. Traders can take a position whenever they want regardless of time.
Real trading in forex is like watching a school of fish move. One minute is total harmony, the next, complete chaos. The forex market can be very volatile. Sentiment, and thus money flows, can change rapidly in the forex market.
Real trading is not something that greedy housewives, retirees or street hawkers can do part-time. It is not for someone who believes he or she can do easily as advertised by clever sales people in the Internet or at most seminars in town. Beware of forex Ponzi schemes.
Yeah, you have been probably told it is a land of easy money. What else? Trade with 100% accuracy, earn a regular income every hour, the secrets of trading, etc.
The reality is much tougher. It is a long learning curve covering areas such as money management techniques, research abilities and level of discipline.
Risks & reason
I have always emphasised on the importance of investment diversification in the offshore context for medium to long-term investors. The potential forex risk should not be overlooked here.
Most serious investors are usually concern about whether the local currency of the invested foreign assets will appreciate or depreciate against the home currency.
If the local currency appreciates against the domestic currency, then investors will have additional return to the returns earned from the foreign assets.
If the local currency depreciates against the domestic currency, then loss from the forex will reduce the returns earned making net returns lesser than should the investment had been transacted purely in the domestic currency.
Once the potential forex risk is identified, they need to consider whether to hedge or not to hedge. In portfolio management to tackle forex volatility, a fund manager may choose the right hedging instruments such as currency futures to help manage the forex risk.
Although the actual forex rate will continue to fluctuate, the manager has locked in the forex rate over the life of the contract. If volatility resulted from forex market can be reduced significantly, the benefits derived from offshore diversification would become more apparent and manageable.
It is hard not to touch on the greenback in this forex article. As I run around the country meeting with so many people, I hear a crying that has become all too familiar.
America has lots of economic problems and the country is finished. The US dollar is going to collapse and will be replaced by the Chinese Yuan. I say nonsense to all these stuff.
The view here is that for any serious investors, an exposure to US dollar is necessary. While the gloom and doom-sayers spend too much time absorbing conspiracy theories from the Internet and bashing America and the greenback, I have been a dollar bull over the years.
Well, who needs that free dollar collapse guide with the rest of the world in troubles too?
About the author: With over 22 years of investment advisory and industry experience, YH Wong is well-known for his contrarian investment thinking.
His writings and commentaries appear often in public publications and he is a frequent speaker at private events for individuals as well as institutional investors.
He can be contacted at email@example.com