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By Betsy Waters, global head of dbFX.com
Investing in foreign exchange (FX) used to be the exclusive preserve of an elite group of hedge funds, investment banks and multinational corporations. These institutions guarded their turf fiercely and no wonder. Between 1990 and 2006, FX investments returned 9 per cent a year, more than either bonds or equities over the same period.* But for individual investors, the FX market has been effectively off-limits: minimum trades were as much as $1 million, and there were a myriad of complex legal documents to review and sign, as well as extensive credit checks that were required before a bank would consider trading with you. Over the past ten years or so this has all changed. Thanks to the advent and growth of the Internet, online trading systems - which give ordinary investors direct access to the currency markets - it is now possible for the retail investment community to easily and quickly trade on the international FX markets from any internet capable PC. And investors don't' have to have large sums of capital to get involved. It is possible to set up an account and start trading with an initial investment of as little as $5000. Crucially, individuals can also now obtain all the data they need to trade FX at negligible cost and are able to trade at the same speed as banks and hedge funds using this platform. They are able to get streaming real-time executable prices and access to up-to-the-minute research to help ensure they have sufficient information they need to make an educated and sound investment decision. Why should investors look to FX as an asset class? How can currency add value to an investment portfolio? One of the most important reasons to consider investing in FX is that it has a track record of generating positive returns on a consistent basis. Research conducted by Deutsche Bank shows that FX Investments returned 11 per cent a year on an annualised basis between 1980 and 2006 with 21 positive returns and five negative return years. In addition, unlike individual bonds and shares, FX returns are not directly correlated to the world's equity markets and fixed income markets. As most investors know stocks or stock indices, even when varied by country or industry, tend to move in synch. Of course, FX is not the only asset class to offer this benefit: commodities and private equity funds also offer the same "diversification" benefits, but FX is probably the least well known of the three. It also has an unusual dynamic not shared by other asset classes, namely that a significant proportion of its trades are executed to hedge risks and not to generate profits.These two characteristics create regular trading opportunities for investors who have the technology to keep in touch with market-changing events and react to them. In terms of trading strategies in the currency markets, the three most widely known are the carry trade, valuation trade and momentum trade. Of the three, the carry trade is the most widely known, although its popularity has dimmed in recent months. A carry trade is where an investor borrows low-yielding currencies and buys high-yielding ones. While less well known, the momentum and valuation trades are no less important. Currencies appear to trend over time, which suggests to momentum traders that using past prices may be useful when investing in currencies. This is largely due to the existence of irrational traders (such as institutions that are trading FX in order to hedge their positions not to generate an investment profit). For valuation trades, in the long-run, currencies tend to move back to their fair value based on Purchasing Power Parity (PPP). However, in the short to medium term, currencies can deviate from their PPP values due to trade, information and other costs. This allows traders to potentially profit from currencies as they revert back to their fair values over the long run. * Source: DB Global Markets Research, worst FX is momentum Betsy Waters is global head of dbFX.com, the retail currency trading platform of Deutsche Bank Useful links: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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