Rodney Norman lives a few miles from the Las Vegas strip. But the 40-year-old independent film producer is not much of a gambler -- unless you count his penchant for foreign currency trading. Three years ago, Norman put $250 into an online trading account and doubled that when he became comfortable with price charts and economic indicators. He now spends a few hours a day exploring the market for ideas and has steadily built up the account to about $25,000, betting mainly on the U.S. dollar, Swiss franc, and British pound.
Until recently, foreign currency trading, known as forex or FX, was largely the domain of professional traders and high- net-worth individuals. But many new Web sites now offer accounts with minimums as low as $250, making it affordable for savvy individuals to play. Although there are dozens of sites, it's best to stick with the largest and most established, FOREX.com and FXCM.com
Similar to commodities or options, the forex market is a way to diversify or hedge a portfolio. Since you make money by playing the relative movement of one currency against another, there's no such thing as a bear market in currencies.
But forex is a 24-hour market, and it moves more quickly than the stock market, with currencies sometimes going up, down, and sideways in the course of hours. Indeed, it's not for buy and hold investors. Some 80% of traders are in and out of their positions in a week or less. Given the dynamics, you should play only with money you can afford to lose.
All trades involve pairs of currencies, typically among "the majors": the U.S. dollar, euro, Japanese yen, Canadian dollar, Swiss franc, British pound, or Australian dollar. If you think the U.S. dollar will weaken against the yen, you would sell dollars and buy yen. FX is largely commission free, with the trading cost built into the spread between the bid and ask price. Leverage is also common: If you have $5,000 in a margin account with leverage of 100 to 1, you can buy up to $500,000 of currency. That can amplify your gains and losses.
Let's say you decide the U.S. dollar (USD) is undervalued relative to the Swiss franc (CHF). In that case, you would buy dollars and sell francs in anticipation of a rising exchange rate. The current bid/ask price for USD/CHF is around 1.2895/1.29, meaning you can buy $1 for 1.29 francs. Using leverage and putting up $1,000 of your $5,000 margin account, you buy one lot -- the equivalent of buying $100,000 and selling 129,000 francs.
"IT'S A BRUTAL, BRUTAL WORLD"
If the exchange rate rises to 1.2935/1.2940 and you want to realize profits, you would sell $100,000 and get 129,350 francs, netting 350 francs. At prevailing rates, the profit would be around $270, or 27% on that $1,000 trade. Conversely, if you were wrong and the rate dropped to 1.2855/1.2860, you would lose $350, or 35%. Should the rate continue to fall, your margin account could be wiped out.
Currently, some investors, including Warren Buffett, are betting against the U.S. dollar in light of a rising current account deficit. Pros are bullish on the Canadian dollar. The country has an account surplus and is benefiting from strength in the oil market.
Even though currency traders look at long-term macroeconomic trends, the short-term nature of FX means they rely heavily on technical analysis. They study price charts to forecast which direction a currency is headed. They also pay close attention to economic indicators such as gross domestic product, nonfarm payrolls, and housing starts.
Forex is a global minefield that can trip up some of the smartest minds, as it has Buffett of late. "It's a rush because the market moves so quickly," says T.J. Marta, senior currency strategist at RBC Capital Markets. "But it's a brutal, brutal world." As such, a disciplined trading strategy with entry and exit points is critical. Stop loss and limit orders help keep trades within a range and curb losses. It's worth testing trades at an online demo, available at most e-brokers, before putting money at risk.
Newcomer HedgeStreet offers online products known as Hedgelets that let you make daily or monthly bets on the dollar in relation to the euro, pound, franc, or yen (hedgestreet.com). There is no leverage, and the Hedgelets limit potential losses and gains -- between $0 and $50 per contract. Prices are reasonable; HedgeStreet charges $1.50 for the first 30 contracts. If forex makes you nervous, this is a somewhat tamer way to trade in currencies.
By Adrienne Carter