Forex a Foreign Language

Foreign Exchange Trading can be a bit of a nightmare for those who don’t know anything about it. The word quagmire comes readily to mind. But if people use words that are small enough and sentences that are short enough and speak in terms that a non-fiscally minded person can understand then the quagmire clears somewhat. For instance:

Did you know that the global foreign exchange market has a daily turnover of US$1.2 trillion? This is rather a lot of money. We know that it’s a lot of money because Tom Cruise hasn’t dared to demand it as a pay cheque yet, and Jennifer Lopez’s backstage demands haven’t reached that amount yet either.

Apparently an investment in the forex market is not like a traditional investment with the hope of a potential positive return, rather it is a hedge against inflation caused by local currency fluctuations.

Hedge – to hem/hinder or restrict; to minimise or protect against loss by counterbalancing one transaction against another; a securities transaction that reduces the risk of an existing investment position.

Hedging Strategy – this involves some forward thinking, it is when a company buys a years worth of foreign currency at a set rate, the set rate prevents fluctuations and allows the company to budget accurately. A hedge secures your investment. E.g. Buy gold if you hold US$ as they are in an inverse relationship, this is a hedge.

An investment in currency is a hedge against all other investments. If all your investments are domestic it is recommended that between 10 – 20% of your portfolio be invested in forex trading. If you already invest in foreign markets then it is recommended that 38% of your portfolio be invested in forex.

A forex dealer buys and sells in currencies, he or she speculates on whether or not the currencies will go up or down in value and then he or she makes a decision to buy a currency. While you own a particular currency you bear the interest of that country, so if the interest rate is 5% you will only earn 5% interest on your investment, but if the interest rate is 12% you will obviously earn 12% interest. It is attractive to buy currency that has a high interest rate and to sell currency that has a low interest rate.

Central Banks play a very important role in foreign exchange trading; they have to keep their own trade balance, currency value and stable economy. They will intervene if need be and print more money to increase supply. Central Banks do not speculate on the foreign exchange market, their role is strictly supervisory and to intervene when necessary to maintain the delicate balance of their country’s economy.

You should now be able to see through the top layer of the quagmire. It’s ok if it’s still a bit murky, that’s what we pay professionals for, to do this kind of thing for us. Alternatively you could take an online course and learn about forex on a more in depth level and play the market yourself. If one currency is not enough for you, perhaps the foreign exchange market is just what you are looking for. But remember this: Good hedges make good neighbours.