Thoughts On Forex Trading

Today I’ve been thinking about Forex trading, and thought I’d share some of my research and opinions on the matter.

What spurred all this off was an infographic that I received in an email this morning. It showed the countries that rely on tourism the most, which got me thinking – I’ve always seen Forex trading as a bit of a scam / gamble, but if I had started Forex trading the moment that I heard the news of the Lockdown, I figure that I would have been making easy money. This would no longer be gambling, it would be smart investing based on economic events. So I started investigating.

My first port of call was to look at the NZD vs USD price to confirm my idea and see how the market reacted to the news. Upon doing so, I immediately I saw a problem: the market had reacted to the news prior to the event occurring. This was either luck (unlikely), insider trading, or lockdowns were happening elsewhere prior to the NZ lockdown.

Looking into this, the NZD seems to have started going down against the USD 2 days after the first lockdown, which was announced in Italy and occurred a couple of weeks before NZ’s lockdown. Prior to the decline in the value of the NZD, Italy, Saudi Arabia and Mongolia had gone into lockdown. This is an indication of how well informed a trader should be, and also how quick to react / paranoid one must be. Though it does highlight that there are opportunities for someone who is keeping abreast of world news and is willing to have a punt.

The Downsides Of Forex Trading

Considering the above, you might think that Forex trading is worthwhile because you can just wait for such an event, then if you can act quickly enough you can make a quick buck. However there are some downsides to Forex trading that make it not so simple.

First of all, these events occur very infrequently, and previous events haven’t been so easy to time, like the GFC. Secondly, it’s hard to know for sure how each country will react – while global investors’ finances typically retreat back to the USD, causing increased demand (and therefore price) for the USD, it’s impossible to know which country will take the hardest stance on currency policy (not to mention guesses as to the magnitude of effect).

For example, you may think that currency X is worth investing in because they are experiencing inflation and are offering massive interest rates on holding accounts in that country; but the question is, how successful are that country’s monetary policies are subduing that inflation? If the inflation isn’t kept under wraps, the value of the currency is eroded away and it doesn’t matter that you’ve doubled the amount of money you have due to interest rates. You simultaneously have the same problem with the currency pair that you’re trading currency X against.

The fact of the matter is, that you have to know things that are absolutely impossible to know.

Speaking of trading in things that you can’t possibly know about, there are people in the market who absolutely do know – because they’re in control of currencies – such as countries with authoritarian leaders who will no doubt have worked out that they can place bets on the value of their currency changing, then manually change it.

Another problem is that (ironically) you’re not trading anything that has an intrinsic value against it. For example, it’s not like trading shares, where someone buys some shares, the company grows and the shares are worth more. The shares are then sold to the next person for more money, who then holds onto them for a while and benefits from the same growth. Currency doesn’t have an eternally growing value (actually in most [if not, all] countries, it’s value depreciates over time). This means that if things don’t go your way, you have to either accept the loss on the trade or hold, with years of opportunity cost and depreciation.

And how about those losses? Because currency doesn’t move by much, Forex traders use leverage when trading – meaning that they borrow a large amount of money relative to their own investment. This leads to either big gains or big losses, essentially magnifying the result of any trade.

Another concern I had when researching Forex trading was that there was only one company I could find in NZ that was registered as a Licensed Provider with the FMA. Perhaps more concerning was that on the Financial Markets Authority (FMA) website, the article about Forex trading basically advised people not to do it, and stated that they regularly receive complaints and enquiries from consumers who have lost money in online forex trading, and that was on the second line of their page about Forex trading.

To support this, according to Stuff, the FMA receives more complaints about foreign exchange schemes than any other type of financial service provider. That’s actually quite a good article on Forex trading and covers a bunch of points that I wanted to cover, but won’t because I’m realizing that this list is getting long. There’s also another good article on the NZ Herald if you want to read more about the negative aspects of Forex trading.

The Upsides Of Forex Trading

After a lengthy lambasting of Forex trading, if you’ve managed to get this far, firstly well done! You have the stamina of an octagenarian sugar addict who has confused his Tic Tacs with his Viagra medicine. Secondly, I do believe that Forex trading plays an essential role in international trade; hence should not be ruled out completely.

Forex trading (or rather hedging) is entirely appropriate for companies who are trading internationally and need to be able to ensure that the prices they charge their customers in one currency, can cover the Cost Of Goods Sold (COGS) accrued in another country. In fact, I would say that it is essential for such a company.

That said, it should not be used by such a company as a form of gambling on profitability from international trade.