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Dec14
FX and the US Dollar
I see infomercials most Saturdays for FX trading systems.  They promise enormous returns for reasonable risks.  I'm here to tell you, it's not that easy.

Foreign Exchange (FX) is not considered a separate asset class by most investors.  Rather, it is an attribute of other assets.  That is, I can price my asset (say oil) in US Dollars (USD), Japanese Yen (JPY) or Great Britain Pounds (GBP).  Today a barrel of oil might have been USD 56, or JPY 6,577.2 or GBP 31.469.  They all are exactly equivalent to the price of one barrel of oil.

Another way of saying that it is not a separate asset class is to say that it does not have any expected return on its own.  Unlike stocks that have an expected positive return or an upward sloping beta curve, FX has a curve that fluctuates around zero.  When you add an FX component to an asset, you add volatility (or risk) without adding any expected return.

The vast majority of FX is used to purchase assets denominated in currencies other than the home country currency.   Trade, services, foreign direct investment,  purchases of  stocks and bonds  and hedging of FX exposures account for  much of what  gets traded each day.  Speculation, or buying and selling FX for a profit is a smaller portion of the $1 to $2 trillion in FX that gets traded each day. Currencies trend, that is they trade in one direction against another currency for a period of time.  They also have volatility clusters, that is periods of abrupt large moves.  Institutional investors might hire a currency overlay manager to try to capture some return from the movement of exchange rates.  The very best of these managers might earn one to three percent return over very long periods of time.  They will also experience periods where they loose money.

Retail investors who use the FX trading systems to buy and sell FX are competing against these professionals.  A retail investor might make money for a short period of time, say a couple of years, but then they might lose it all in a large move like happened today in the USD versus the JPY.  The dollar went from 120 yen yesterday to 117 yen at the close today.  That is a huge move in currencies.  I have seen even more abrupt changes of 5 standard deviations or more.

My advice would be to spend the time and effort in a market with better expected returns like the stock market.  You will probably do far better in the long run.

2 Comments/Trackbacks




I cerainly agree with Larry, that undisciplined investing in the FX market is risky.
However, investing in the stock market has similar if not greater risks.
Day-trading the FX markets allows traders to take advantage of the daily fluctuation of the markets; and a tested trading system will allow those traders to employ practices of stop-loss; risk reward; and portfolio risk per trade.

Chris, see my response in the next post. Thanks for the comment

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