Forex investment lures Kiwis

0 Comments | Press, The; Christchurch, New Zealand, May 31, 2005 | by GREENE, Kristina

Spot swaps and arbitrage deals are no longer a mystery to New Zealanders. In the second part of a series on alternative investment, KRISTINA GREENE looks at foreign exchange trading.

Long on Swiss francs, short on yen. Asking euros, selling US dollars. Pesos against rupees, dinars, Australian dollars, Swedish crowns and Canadian dollars — there are opportunities for every preference. And juggling currencies on the foreign exchange, or forex, is a high-risk and high-potential game Kiwis are becoming increasingly eager to play.

The foreign currency market is the largest financial market in the world, and growing fast. According to a survey by the US research group Greenwich Associates, the value of online currency trading worldwide doubled from 2003 to 2004, and now exceeds $US8000 billion ($NZ11,200b). New Zealand’s daily trading is about $100 million.

Investors take on considerable risk on the foreign exchange market, or forex. Currency transactions allow market participants to trade much larger amounts than they have on their accounts as brokers normally require low margin deposits. For example, with a margin ratio of 20:1 and a deposit of $10,000, an investor/ speculator can trade amounts up to $200,000. Trading in larger volumes, in turn, allows these investors to take better advantage of small price movements.

But conversely, potential losses are proportionate to possible gains: traders stand to lose way more than they have on their accounts if things go wrong.

Trading experts warn currencies are among the world’s most volatile asset classes, saying foreign exchange markets are suitable for speculation rather than investment.

People who trade currencies tended to take very short-term positions, says OMFinancial head of foreign exchange James Davies.

“Currency futures should never be the main part of an investment because they are highly risky.”

He recommends investors should hold no more than 5% to 10% of their total investments assets in currencies.

“People are drawn to it because there are huge potential gains, but losses can be huge as well,” he says.

However, the high liquidity and efficiency of currency markets mean an increasing number of investors are diverting money from the share market to the forex.

While currencies are traded around the globe, 24 hours a day, five days a week, stockmarket shares are vulnerable to liquidity risks owing to limited trading volumes and market accessibility.

Moreover, large price movements may occur on the equities market after single transactions.

In comparison, trading volumes in the currency markets can be 50 to 100 times larger than the New York Stock Exchange, meaning traders are more likely to find dealers willing to buy or sell currencies at fair market price than they are on the stock market.

Currency transactions are also low- cost, as they typically incur no commission or transaction fees, and brokerage costs are about $50 for $100,000 placements.

Dennis, a former seed crop grower from Idaho in the United States, who now lives in Tauranga, started trading in forex six years ago after his US company took in a sudden $500,000 ($NZ707,000) loss.

“I was a typical American who took no notice of currency markets and believed we had made a big profit because sales were going wonderfully. It turned out we had made a huge loss on account of translation (conversion) losses,” he says.

Dennis says he started reading everything he could get his hands on, and began trading to protect his company assets.

He says he will continue trading currencies to protect sales in the US, Canada and South Africa.

“It becomes part of doing business.

“The first time you lose sleep, but you can’t allow yourself to become emotional.

“Most of all, you need a really good broker, because if you’re on the wrong side, the market will have you for lunch.”

His losses are now limited to one- off, $30,000 hits, and he uses two trading accounts holding $100,000 and $700,000 respectively to trade currencies and commodities.

Historically, smaller-scale, individual investors have had limited access to the forex market, which was dominated by major banks and multinational corporations.

However, internet-based access platforms such as Oanda have played a part to democratise entry and opened up the marketplace to a new breed of investors and speculators
forex arbitrage