Investing

Forex isn’t easy to predict. If you think picking where a share price will head is difficult, imagine the variables influencing the movement of a currency: global politics, economics and the local factors that affect every other currency against which the Australian dollar is measured.

“In studies, we’ve found the majority of people lose money trading FX,” says Jim Vrondas, head of client dealing at OzForex. “It’s not something we do and we don’t promote it.” He has previously worked in an investment bank where part of his role was to speculate on currencies and trade them on the bank’s behalf. “In order to be successful, it does take a very strong discipline and personality type to do it well.”

For those who want to take a more active position on the currency, the obvious way is through contracts for difference. These offer investments over a host of different asset classes – local and global shares, bonds, commodities – and currencies are very much in the mix.

David Land at CMC Markets says foreign exchange and index CFDs are the two most popular areas on his platform in Australia. And Chris Weston at IG Markets says trading the Australian dollar is the single highest-volume product that platform offers.

Lots of leverage

CFDs allow you to leverage, and of all the products available on CFD platforms it’s currencies that offer the greatest degree of leverage.

At both CMC Markets and IG Markets, the margin required is typically just 1 per cent. That means for $1 of commitment you get $100 of exposure, or for $100 of commitment you get $10,000 of exposure. Clearly, this magnifies risk as much as reward. You can make 100 times your money – and you can lose that much too.

IG Markets’ Chris Weston says: “Make no mistake, currency trading does carry a high degree of leverage. You need to understand that you can both make and lose a lot of money if you don’t know what you’re doing.”

Not like shares

That said, providers do point out that FX tends to move in a different way to shares. “The standard quotation mechanism for foreign exchange is to four decimal places,” Land says. “So for someone trading $10,000 (the industry standard minimum trade size) that works out as $1 per tick movement.

“That’s why the margin on FX is so low: if it was high it would become very expensive, in terms of overall margin, to trade it. The more liquid the product and the longer the hours it trades, the lower the margin will be. FX markets are the most liquid.”

Short attention span

In practice, how do investors use the FX facility on CFDs? “There’s a real spectrum of people who trade FX,” Land says. “A lot of people view FX as being a short-term market for intraday traders, that’s the popular opinion of it. But there’s a growing element of people who are keen to trade it as a position – not necessarily for the same length of time as a share CFD, but not that much different.”

This makes more sense for people who have a long-term view on a currency and are prepared to wait to be right. “FX provides big trend moves over an extended period of time,” Land says. “People are getting more keen on capturing those moves with FX.”

But, with the vast majority of trading taking place against five major currencies (the US dollar, euro, sterling, Swiss franc and yen), Land points out: “Someone who is looking to capture big trending moves may have to wait a fair while between drinks for the right set-up.”

Weston, though, says: “CFD traders by their nature aren’t particularly long traders, and currency is usually only a couple of days”. But he adds: “The bulk of FX is a technically oriented market, because there are so many different working parts. A lot of currency traders use technical analysis.” That puts it into the realm of people who enjoy using charting strategies for their share investments.

On platforms like these, the AUD/USD cross is by far the most active for Australian investors, followed by other Australian-dollar pairs such as yen, sterling and New Zealand dollar. “People like trading the Australian dollar because they have a relationship with it,” Weston says. “They use it every day. People understand how it moves, how interest rates will affect it, how commodities will move it.”

Million-dollar question

And where’s the currency going? That’s a (more than) million-dollar question. Drew Corbett, head of investment strategy and distribution at BetaShares, says: “We’re not sure how long the gains will last and when the $A will retrace.”

Remember that even at $US1 many people weren’t sure it could go much higher. And analysts are divided but most expect continued strength for a while yet.

AMP Capital Investors chief economist Shane Oliver said in mid-2011: “Unless the global economy slides back into recession, which appears unlikely, the $A is likely to average above parity [dollar for dollar] over the next few years on the back of strong commodity prices and relatively high Australian interest rates.”