Trading isn't something one can learn through reading books or research alone. Like riding a bicycle or jumping into the deep end of a pool, it's something you've got to engage in to actually understand. There's no substitute for on-the-job training.
And if you want to actively buy and sell, there's simply no substitute for spot foreign exchange, a high risk but intoxicatingly addictive asset class which barely existed in its current form just a few years ago. It's like manna from investor heaven.
For the nearly 30 years after the end of WW II, global exchange rates were fixed to the US dollar, a scheme which remained in place until August 15, 1971, when President Nixon dropped the U.S. dollar convertibility to gold, leading to an irreversible breakdown of the system of fixed exchange rates and opened the door to the free float of major world currencies.
Trading those currencies was for decades almost exclusively the domain of banks and institutional investors, along with a relatively small number of investors who traded futures contracts based on currencies such as those listed at the Chicago Mercantile Exchange (CME) .
That dynamic has changed dramatically, however, as advancements in technology opened up spot FX to nearly anybody. More than any other asset class, it offers exactly what most active traders want: volatility, action and surprisingly small capital requirements.
What likely appeals most to active traders is the action. Foreign exchange is the world's most liquid asset class, a nearly 24-hour market that's just as active at 9 p.m. most weeknights as it is at 9 a.m. most mornings. Consider that, even with pre- and post-market activity, stocks are still only open about 8 hours a day. Foreign exchange literally never stops: from Sunday afternoon to the following Friday night, there's nearly always something moving.
There is a learning curve to FX. After all, stock investing is a fairly straightforward process. Buy 100 shares of Microsoft (MSFT) and you own an equity (ownership) interest in the company. Your profit (or loss) is determined to the extent Microsoft either rises or falls, along with any dividend the company pays over period you own the stock. We're all quite familiar with that game.
Currency trading involves speculating on the price relationship between two different entities, simultaneously buying one currency while selling another with the hope that one buys a currency that will appreciate relative to the currency that has been sold.
So while stocks are quoted simply in terms of share price, currencies are quoted relative to one another. When referencing the value of the U.S. dollar against the Swiss Franc, for example, a recent quote would be somewhere around USD/CHF=0.9312
The quote specifies how many Swiss Francs you have to pay to buy one U.S. dollar or, conversely, how many U.S. dollars you'd get when you'd sell one Swiss Franc. In a currency pair, the first currency quoted, usually the U.S. dollar, is referred to as the base currency. The second currency, in this case, the Swiss Franc, is referred to as the quote currency.
If you wanted to wager the U.S. dollar would rise against the Swiss Franc, you'd go long (buy) the USD/CHF pair. Conversely, if you felt the U.S. dollar would weaken relative to the Swiss Franc, you'd short USD/CHF. There are literally dozens of active FX pairs, many of which like GBP/JPY (British pound/Japanese yen) or AUD/NZD (Australian dollar/New Zealand dollar), don't involve the U.S. dollar at all.
And unlike stocks or futures contracts, spot FX generally doesn't involve trading with other investors directly, but with dealers like Gain Capital (GCAP) or FXCM (FXCM), who maintain a continuous two-way market to buy or sell anywhere from $1 to $100,000 or more worth of currency.
Most FX platforms charge no commission to buy or sell, rather the trader simply pays the spread between the bid and offer for each currency pair. The more actively traded currencies have more tightly quoted spreads and the best chance for success.
Stock investors will spend hours or even days researching companies, evaluating management or new products. In foreign exchange, however, you're not buying or selling shares in a company, but the relationship between two different currencies, a complex and inherently unstable relationship that lends itself to a shorter-time horizon.
We often let stock trades become investments, waiting for underwater positions to recover for months or even years. When a foreign exchange position is moving against you, you're rightfully not thinking about the country's GDP, president or long-term prospects, but your own position, margin and tolerance for risk.
The detachment and indifference to the underlying asset is actually a major benefit in that it permits one to learn the patience and market psychology of how to trade, including the basics of money management and controlling risk. And because most of the platforms have relatively low capital requirements, one can experience trial by market fire with an aggressive portion of their assets rather than the whole nest egg.
In the mid-1990s, I was interviewed for an MTV documentary, which captured several shots of my then-state-of-the-art QuoTrek receiver, which used FM signals to receive crude price quote on stocks and foreign exchange.
Now smartphone apps like those from Oanda offer institutional-quality foreign exchange trading from literally the palm of one's hand, something that was unthinkable even a few years ago.
FX isn't a clandestine road to riches. But for aggressive investors looking to actively trade a portion of their portfolio, it's the world's best game.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC
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