Recently there seems to have been a bit of an explosion of Forex investment related posts around a few personal finance blogs. Indeed I get contacted regularly by various guest posters looking to publish articles on Forex investing. As with all guest posts on here, I want them to be unique, interesting and most importantly: Promoting the good financial habits I believe in. So, instead of the normal investment promotion post I was happy to receive this one which highlights the keys risks associated with such investment and shows us that there is no such thing a guaranteed return however higher risk can appeal to some investors.
For anyone hoping to build up a retirement fund early in life, diversity is particularly appealing. Diversification of a portfolio reduces your long-term risk by spreading out your investments, rather than keeping them all in one boat, so to speak. So basically, if you have investments in 10 different stocks and three of them lose money over a period of time, you’re likely to make up the loss through the other seven. Of course, there’s also a risk that all 10 could lose money, but this is very unlikely. On the other hand, if all of your money is tied up in a single asset and that asset decreases in value, you have no safeguards or other investments to offset the loss.
That’s the core concept, and it’s what leads many people building retirement funds to explore a wide range of investment opportunities. Sometimes, this simply means investing in a variety of stocks, but it can also mean looking into other markets entirely. And this is where forex trading occasionally comes up.
For those who may be unfamiliar with this market, forex trading basically means buying and selling different world currencies in order to take advantage of their shifting values. For example, if $1 were worth £3, you might take the opportunity to spend $10 to buy up £30. You’d then hold that £30 until a time at which the dollar gained value in relation to the pound. If after a week $1 is suddenly worth £2, you could sell your £30 back for $15, essentially gaining $5 in your own currency from your starting point. That’s a simplistic example, but it illustrates the basic idea and shows how leveraging currency values against one another can essentially increase the value of your money.
But is this type of trading worthwhile as a means of diversifying your retirement fund? That’s debatable, but here’s a look at some of the potential risks and rewards of the idea.
The clearest issue with using forex within a retirement fund actually has little to do with the risk of the actual trading method, and more to do with the style. Forex markets experience high volatility throughout each given day, and sometimes it’s within that volatility—the quick spikes and drop-offs in currency values—that there’s real money to be found. As such, the forex market can be better suited to busy day traders than long-term investors.
But the same volatility can also constitute a specific financial risk to investors. Basically, things move so quickly that some believe looking at forex as anything other than gambling is foolish. Now, there’s an argument to be made that all investing is on some level similar to gambling, but the point here is that the quick-moving, often-unpredictable nature of the forex market makes it a particularly risky trading environment.
And finally, forex is also treated with a degree of skepticism by many disciplined investors because by its nature it’s unregulated and influenced by an enormous variety of factors. Many believe that private investors are at a disadvantage because the market is dictated by professional brokers dealing in huge amounts. And even if you overlook that problem, the simple fact is it’s hard to get a handle on forex movements and price patterns because so many different things—from a government’s internal economic policies to geopolitical tensions—have an impact.
One of the main benefits often cited with regard to forex trading is it can actually be easier to recognise trends. This is simply due to the high liquidity of the forex market (meaning the amount of money at play at any given time is so large that transactions just don’t impact things that much). An average of about $4 trillion changes hands in the forex market over the course of a given trading day, which means this level of liquidity is pretty reliable.
Additionally, some who do have the time to keep an eye on their portfolios and conduct trades on their own appreciate the fact that there really aren’t that many options to keep an eye on. In fact, eight currency pairs account for 72% of market volume, which is almost like saying the entire stock market is comprised of eight different assets. This doesn’t necessarily make it easier to forecast price movements and make effective trades, but it can make the overall experience a little less overwhelming.
As a last point, and more of a detail than a reward or “pro,” so to speak, is that the forex market operates 24/7, with some unusual active hours. Because the market involves all major world currencies, there are always certain pairings moving more than others, and it’s possible to become a disciplined forex trader by taking advantage of this through off-hours trading. Again, most people setting up retirement funds want to be investors rather than day traders, but it’s certainly plausible to make a habit of devoting a few strategic hours a day or night managing this aspect of a portfolio.
There’s no absolute answer as to whether any investment is more of a risk or more of a potential reward. The very nature of investing implies both risk and reward potential. But for those considering diversifying retirement funds by branching out into forex, it’s worth considering the quirks of this particular market. For those who really get the hang of it, there’s certainly money to be made. But it’s an unorthodox form of investment that can be even riskier if you’re not going to be hands-on about it.