While my personal investment style is conservative and focused largely on index funds, one of my goals for this site is to learn about and introduce some of the lesser-known investment opportunities available. With the proliferation of internet access and the rise of the “online broker” over the last decade, even those opportunities that seemed reserved for professionals and the elite are becoming available to the common investor.
One example is the upcoming launch of the Facebook IPO, which will reportedly be made available to investors with accounts at E-Trade and TD Ameritrade.
Playing with Forex
If you’ve ever taken a college-level finance course or browsed some of the brokerage websites out there, you may have heard of Forex. But if you’re like me, it’s very likely that you’ve never looked into what it means to be involved in trading Forex and how you can benefit.
What do I mean by “Forex” exactly? Forex is one of many terms to describe the foreign exchange market, essentially the market where different currencies from around the world can be traded. Some of the other names include “FX” or “currency market,” according to Wikipedia.
Comparing two currencies to one another is done in the form of a ratio. Essentially, you might get 10,000 Bongo Bucks for every 1 Dollar, or 6.57 Googoos for every 1 Dollar, and so on.
As currencies are traded and the forces of world markets act on currencies as a whole, and individually, these ratios will change. That’s what happens when you hear about the dollar, or another currency getting “stronger” or “weaker”—it’s worth with respect to other currencies is improving or worsening.
Currency trading attempts to exploit these shifts in relative value. Just like like the stock market mantra “buy low, sell high,” the idea with currencies is to “buy weak, sell strong,” picking up world currencies when they are undervalued and sell them back when their value grows.
One unique characteristics of trading currencies is that you always have money—you’re not trading your cash for stock in a company, or for a commodity, but simply exchanging it for another county’s form of money. Pretty neat, if you ask me.
Until the last few years or so, “the thing” to do if you were living in Poland, where most of my family resides, was to invest as much of your savings as possible in U.S. Dollars. There were a ton of banks in Poland offering strictly dollar-based accounts.
The main reason is that the Polish Zloty was subject to hyper-inflation after the Cold War wrapped up. In fact, the Zloty was redenominated in 1995 with 10,000 “old” Zloty being exchanged for each “new” Zloty. Inflation continued, with the Zloty worth less each passing year against the dollar, which meant that those who were holding dollars in their account were not only getting interest, but investment gains to boot.
The exchange rate of the Zloty against the Dollar held in the 3.5 to 4 Zloty-per-Dollar range for the better part of 2000 to 2005. Then a curious thing happened—it fell to nearly 2.0 in 2008. All of the dollars Poles had in their accounts now had only half the buying power in Poland as only a few years before. The rates eventually recovered to the low-3 range, where they have stayed for the last few years.
This example illustrates that, while there is tremendous upside potential and risk protection potential in currency trading, there is also a lot of potential downside risk to consider.
Online brokers are making long-term and short-term currency trading available to the everyday consumer. As these methods become more commonplace, it’s important to understand their risks and benefits, so make sure you meet with your financial professional or investment advisor before taking any action.