This article is the sixth article in a series of finance articles by Steve Bishop, a retired accountant living in Bodrum.
Other articles in this series:
Part 1: No Interest?
Part 2: To Trade or not to Trade…
Part 3: Choosing Shares
Part 4: Turkish Mutual Funds
Part 5: Interesting Deposits
Part 6: Currency Trading
Part 7: Comparing Investments
The lira could crash due to the judicial conflict with the military in Turkey. The £ could crash after the next election if there is a hung parliament. The euro is crashing due to the massive debts of some of the (PIGS) euro nations. The dollar…..
Foreign exchange is a complex business! And it affects all of us every day. Have you noticed how much the price of instant coffee in Bodrum supermarkets can vary from day to day? Prices can change 10, 20, 30% overnight due to movements in the lira exchange rate (despite of course the fact that the jars were purchased weeks ago at a different rate). Exchange rates impact import and export prices, interest rates, inflation and so on. Ten years ago, Bodrum traders wanted dollars in preference to liras. Then they switched to euros. Now the euro is falling fast it will be interesting to see the currency of choice for 2010.
FOREX (or FX) trading is not for the feint hearted ! You can make a lot of money very quickly but, unlike the other types of investment we have looked at, you can lose everything in a few seconds. Having said that, if you are willing to devote serious time and effort to learning FX trading, it is possible to earn a good income with just a home computer and a few thousand working capital. You can open an FX trading account with one of the internet based trading firms in a few days.
As with share trading, there are many forms of FX trading. These include spot forex, futures, options and spread-betting. Of these only the first is really suitable for the non-professional trader so will be considered here. Spot forex simply means you buy currency at one price and sell it at some future date at another price – the prices being determined by the rate at the exact moment you buy or sell. In addition there is a price difference (spread) between the buy and sell rates of the moment.
Now, many of us already engage in FX trading. We move funds between lira and sterling or euros when we need to. Some of you might keep funds in other currencies for longer periods hoping they will appreciate compared to the lira. As we have seen in previous articles, if you can get your timing right, you can make as much or more than interest on a bank deposit account when changing currency. Real spot trading utilises currency movements over a few seconds to a few months.
The reason that it is possible to earn considerable profit from a small movement in currency is that FX trading to done on margin. This means that your FX account will allow you to buy 20, 50,100 or even more times as much currency as you have in your account. So, for example, say you have £2000 in your FX account and a margin of 50. That means you can buy up to £100,000 of currency. If that currency goes up 1%, then you make £1000 ! The downside of course is it only has to go down 2%, and you lose everything.
To protect your capital, when you make a trade on an FX system, you normally set a stop loss. This limits how much you can lose on that trade. However, this can have negative consequences too. Say you’ve correctly predicted the £ will rise against the euro but before it rises it first falls a little. This activates your stop loss before the £ goes up again and you make a loss despite making a good trade. Very frustrating and a major problem if you don’t really have enough working capital to trade effectively.
Currency is always traded in pairs eg USD/TRY or GBP/EUR. When you place your trade you are predicting that one of the pair will either go up or down against the other. FX software gives you numerous (free) tools to monitor the various currencies over time but, like shares, currencies vary for a wide variety of reasons. Politics, economics, world events, trader sentiments all affect currencies and movements are not always rational. Most traders concentrate on a few currency pairs that they are very familiar with. Some currency pairs are not available and others are particularly volatile.
Fortunately, again like shares, most FX trading web sites allow you to have a free practice account that you can try at no risk. Don’t try it for real unless you are consistently making good profits on a real time FX game system. However a word of warning: most practice systems give you £100,000 or so working capital. This can lull you into a false sense of security as the more working capital you have, the easier it is to make a profit and it is easier to take risks when it is not your money ! Accepting any losses when it is your own money (and all FX traders will lose on some trades) is hard.
Bodrum Bulletin Portfolio update
|BB INVESTMENT||% Change YTD||Best Stock||Worst Stock|
|Portfolio A||+0.66%||CPG +11.2%||NXT -9.6%|
|Portfolio B||-0.68%||CPG +11.2%||NXT -9.6%|
|Portfolio C||+0.77%||BARC +20.6%||PVCS -16.4%|
|Mutual Funds Type B||+1.30%|
|Mutual Funds Type A||+1.25%|
An additional item has been added this issue to our Bodrum Bulletin investment comparison table: an FX trade buying £10,000 of lira on 1st Jan and converting them back at current rates (assuming a 4% spread between bank buying and selling rates). Interestingly, there is currently little difference between a bank time deposit (at 8%) and any of the alternatives.