Profit from currency swings

If you have “investment experience, a lump sum and nerves of steel”, then foreign-currency trading may be for you, says Hugh Clayton in the FT. The market is huge - average daily turnover in foreign-exchange markets globally comfortably exceeds $1trn. And the recent, much-predicted decline of the dollar, along with the volatility of equity markets, has prompted increasing numbers to enter the market.

Over 90% of transactions are purely speculative, making forex a very volatile and liquid market, says Chris Bourke in Shares. Its “the ultimate form of short-term trading”. Private investors can now trade in forex pretty easily (see below) and find a plethora of information on the internet, as well as using virtual trading platforms to hone their skills first. And, unlike trading shares, there is no stamp duty to pay. In the UK, you can trade whenever you want - the forex market (with a daily turnover of $637bn) “never goes to sleep”, thanks to overlapping time zones in different financial centres.

Despite a risky reputation, forex trading also has sound fundamentals, says William Essex in The Banker. It is a great way to diversify, as it is not correlated to any other asset class. Better still, currency speculation is a zero-sum game. Individual currencies may weaken, but there is a winner for every loser - the overall market doesn’t fall. And some of the market’s players are “natural losers”. The actions of corporations who want to reduce risk (and so are prepared to take small losses as an insurance premium) and central banks, (whose main aim is to try to slow down currency movements) leave the way clear for “would-be winners”.

But to hit the jackpot you need to understand how and why currencies move, says Hugo Dixon in The Penguin Guide to Finance. There are three discernible, ‘fundamental’ influences on currency rates over the longer term. These are inflation (high inflation makes a currency worth less), a country’s external balance of trade (if a country imports more than it exports its currency should fall) and its interest-rate differential relative to other currencies (the higher the interest rate, the more attractive a currency). As far as the dollar is concerned, on this basis, the consensus that it is in a downward trend is correct, says Hugh Clayton. Nonetheless, this does not mean its downward path will necessarily be smooth. You can make money from the dollar’s decline, but you have to get your timing right.