by Thomas Schipani

Created on: April 20, 2008

Why is Foreign Exchange currency trading (FX) popular? Individual investors may be drawn to FX because it is a market that has only recently opened to the individual investor in a way that is convenient, easy, and simple. Twenty or even ten years ago, this market was closed to the individual because of high transaction costs and stringent credit requirements. All of this is made possible by the tools of the information age.

In addition to the easy and efficient mechanics of trading, excellent marketing campaigns by dealers have convinced today's FX investors that FX: (a) is simple to understand, (b) since you get money for money it is safe, and (c) it is easy to make a quick profit. While it may be true that the mechanics are easier than they used to be, the rest of the reasons are just plain wrong, not just a little wrong but really wrong. FX trading, at least to me, is a very fast, exciting and dangerous vehicle for the unhedged, the inexperienced, and the unwary investor. To quote PT Barnum, "there's one born every minute".

GOOD REASONS TO TRADE FX

The first good reason is to hedge FX risk. People or corporations with foreign currency exposure can use FX trading to hedge their risk. For example, if you buy raw materials from Europe priced in EURO, but sell the finished product in the US for dollars then when the dollar goes down, as it has, your raw materials will cost more (in dollars) and you will suffer a loss unless you have used FX trading to balance this exposure.

The second is for large banks to balance exposure resulting from foreign loans or trade finance for their own account or, acting as a wholesaler, on behalf of their customers. For really large banks, FX and FX denominated deposits can also provide opportunities for FX arbitrage.

SPECULATING OR INVESTING IN FX?

If you are neither a corporate treasurer with FX risk to manage nor a bank and you are trading FX then you are not, in fact, an investor. You are a speculator.

Since the FX market is defined by how the currencies rate against each other and not on their intrinsic value, straight FX trading is a zero-sum game (just like gambling: I win-you lose). Compare this to equities where the value of a share of stock is determined by the value of the company and, at least to some extent, can rise and fall on its own merits, and where the value of the entire market can, and historically has risen.

VOLATILITY

If you have open positions you are open to market fluctuations and, historically, there is nothing

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