While online equities and futures trading have enjoyed exponential growth and widespread notoriety over the past few years, online foreign exchange trading is only now gaining popularity among seasoned active traders, commodity trading advisors (CTAs), and other professional money managers. Until recently, large international banks dominated the foreign exchange (FX or forex for short) market, only allowing access via telephone trading to a select few such as Fortune 1000 companies, large funds, high–net worth individuals, and so on. But now, the tide has turned and finally, there are established online trading firms that provide individual investors with direct access to the largest, most liquid financial market in the world.
DIVERSIFY YOUR DIVERSIFICATION STRATEGY In addition to the market’s trading opportunities, foreign exchange can be a solid diversification component in your financial portfolio. Most diversification strategies involve a combination of sector allocation, foreign and domestic equities, and fixed income. Some participants have branched out into precious metals and/or energy products; however, Trading opportunities in the forex market deserve serious consideration as a diversification strategy for your portfolio.
Is forex as risky as everyone thinks? One way to measure risk is to compare a financial product’s risk relative to its return. If you take the time to compare an investment in forex to common investments such as equities and fixed income, you will find that from a risk/reward standpoint, forex investments provide respectable returns and should be considered viable portfolio diversification tools. For example, 2001 annual volatilities for the Dow Jones Industrial Average (DJIA), 30-year bond futures, and US dollar/yen (USD/JPY) were roughly 21.5%, 10%, and 10.5%, respectively.
An investment in a basket of major currencies (or USD/JPY) last year was comparable to 30-year bond futures (which was one of the best returns for the fixed income markets in years), and clearly outpaced the negative returns generated by the DJIA. Although forex trading can lead to very profitable results, there are risks involved. When it comes to trading forex, you’ll need to worry about exchange rate risks, interest rate risks, credit risks, and country risks — things you may not consider when trading stocks.