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CANADIAN WEALTH STRATEGIES: CREATING OPPORTUNITY

What is Foreign Exchange (Forex) Investing and how does it work?

Foreign exchange trading was once something that people only did when they needed foreign currency to use when traveling in other countries.  This involved exchanging some of their home country's currency for another at a bank or foreign exchange broker, and they would receive their foreign currency at the current exchange rate offered by the bank or broker.


Just like with trading stocks, forex traders invest to take advantage of profit opportunities in the fluctuating values of currencies between two countries.


The currency market, or forex (FX), is the largest investment market in the world and continues to grow annually. On April 2010, the forex market reached 4 trillion in daily average turnover, an increase of 20% since 2007. According to the 2016 triennial report from the Bank for International Settlements (a global bank for national central banks), the average was more than $5.1 trillion in daily forex trading volume.  In comparison, there is only $25 billion of daily volume on the New York Stock Exchange (NYSE).  

Currency trading is a 24-hour market that is only closed from Friday evening to Sunday evening each week, but the 24-hour trading sessions are misleading. There are three sessions that include the European, Asian, and United States trading sessions. Although there is some overlap in the sessions, the main currencies in each market are traded mostly during those market hours. 

All currency trading is done in pairs. Unlike the stock market, where you can buy or sell a single stock, you have to buy one currency and sell another currency in the forex market. Next, nearly all currencies are priced out to the fourth decimal point. A pip or percentage in point is the smallest increment of trade. One pip typically equals 1/100 of 1 percent.

The majority of the volume in currency trading is confined to only 18 currency pairs compared to the thousands of stocks that are available in the global equity markets. Although there are other traded pairs outside of the 18, the eight currencies most often traded are the U.S. dollar (USD), Canadian dollar (CAD), Euro (EUR), British pound (GBP), Swiss franc (CHF), New Zealand dollar (NZD), Australian dollar (AUD) and the Japanese yen (JPY). Although nobody would say that currency trading is easy, having far fewer trading options makes trade and portfolio management an easier task.

Factors like interest rates, trade flows, tourism, economic strength and geopolitical risk affect supply and demand for currencies, which creates daily volatility in the forex markets.  An opportunity exists to profit from changes that may increase or reduce one currency's value compared to another. A forecast that one currency will weaken is essentially the same as assuming that the other currency in the pair will strengthen because currencies are traded as pairs.

As an example, a Trader who expects interest rates to rise in the U.S. compared to Australia while the exchange rate between the two currencies ( AUD/USD) is 0.71 (meaning it takes $0.71 USD to buy $1.00 AUD). The trader believes higher interest rates in the U.S. will increase demand for USD, and therefore the AUD/USD exchange rate will fall because it will require fewer, stronger USD to buy an AUD.

Assume that the trader is correct and interest rates rise, which decreases the AUD/USD exchange rate to .50. This means that it requires $.50 USD to buy $1.00 AUD. If the investor had shorted (sold) the AUD and went long (bought) the USD, he or she would profit from the change in value. (From investopedia.com)

Top 5 Benefits of Investing in a Forex Fund vs. Stock Market Fund: 

  1. Largest and most accessible market in the world - The Forex Market is the largest and most liquid open trading market in the world, with daily trading volume currently exceeding 5 Trillion Dollars (In comparison, there is only $25 billion of daily volume on the New York Stock Exchange - NYSE). Because of the size there is far less ability for any one institution or country to manipulate the movement of any one currency.  It has very quick turn-around time to return funds on trades - generally forty eight hours.  The forex market is traded 24 hours a day, five days a week—starting each day in Australia and ending in New York.  This gives significantly longer trading hours for forex trading and thus more profit opportunities versus any one particular stock market (The North American stock markets are only open Monday-Friday 9:30 a.m. - 4 p.m. EST).

  2. Currencies move independent of the stock market - Forex market fluctuations generally do not correlate with the stock market up and down movements.  This means whether the stock market booms or crashes, the currency market will not be effected.  It means there are always profitable opportunities in the currency market, as currencies move relative to each other - meaning if one currency goes down, another must move up.

  3. Ability to create more predictable, stable returns - Relatively small movements in currency pairs can translate into large returns as compared to stocks.  A movement in a currency pair of just 2% can translate into a profit of several thousand dollars.  A particular stock or industry can be affected significantly by unexpected or unforeseen events, a good example currently of this would be the trade war going on between the US and China. 

  4. Currencies are backed by Governments and their central banks - giving a larger measure of legitimacy, stability, and consistency to the underlying investment.  When you buy currency pairs you are literally buying money, a store of value and carrying the full backing of the nation it belongs to.  All of the top traded currency pairs are G20 economies: US, UK, European Union, Switzerland, Australia, Japan, New Zealand, and Canada.  

  5. Over 80% of transactions are related to a US currency pair - The US Dollar remains the worlds dominant currency - US remains the worlds largest economy.  The US Dollar remains the primary international reserve currency - US Dollars are the medium of exchange for many major cross border transactions, such as Oil - the US is the largest and most liquid financial market in the world

 

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