 Trading
foreign currency has risks
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 Dear
Dr. Don,
I've heard that foreign currency trading is one of the best investments
to make, having great returns. What's your take on this?
-- Shanna Spot-Market
 Dear
Shanna,
Trading isn't investing, at least how I define
the two terms. It's more speculative in nature. I believe there's
room for some speculative assets in a portfolio, but it should be
a small percentage of the overall portfolio -- less than 5 percent
of portfolio assets.
Foreign exchange, or forex, offers such high potential
returns because you can leverage your money. Leveraging your account
balance by 100 to 1 means you can capture the change in value of
$100,000 worth of a currency with only $1,000 in your forex margin
account. Some accounts offer 200 to 1 leverage. In contrast, a homeowner
that puts 5 percent down on a home purchase only has 20 to 1 leverage.
A currency move can force liquidation of open positions if adequate
margin isn't maintained in the account.
There are different types of trading, from day trading
to position trading. For retail investors, the bid-offer spread
in the cash-foreign exchange market can be too wide to make day
trading currencies a realistic option.
The bid is the price at which you sell the base currency
to buy the other (counter) currency. The offer is the price at which
you can buy the base currency with counter currency. The spread
is quoted in pips, defined by Forex.com as, "The smallest unit
of price for any foreign currency. Digits added to or subtracted
from the fourth decimal place, i.e. 0.0001." The wider the
bid-offer spread the harder it is to be successful in trading currencies.
Position trading, where you are in the currency for a period of
time, includes the interest income/interest expense of the foreign
currency position.
Getting away from trading currency in the cash (spot) market, you
can also speculate on changes in currency values by using exchange-traded
currency options or currency futures.
Use a trading simulation to test your skills as an
forex trader before opening an account. Most shops offer demo accounts
that allow you to do this. Some brokerage firms also provide demo
accounts for options and futures trading. One problem with the demo
accounts is that you tend to be a lot more courageous when you're
not really taking a loss.
If you've got a fully funded emergency fund,
have made decent progress toward building an investment portfolio
for retirement or other financial goals and want to take a flier
on trading Forex for fun and profit, go ahead. Just show some aptitude
for it first by using a simulated trading account and don't commit
more than a small percentage of your investable assets.
To ask a question of Dr. Don, go to the "Ask
the Experts" page, and select one of these topics: "financing
a home," "saving & investing" or "money."
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