Sunday, April 04, 2010

Investing in Foreign Currency

Some people like to invest in foreign currencies to earn a higher yield. For example, they can earn 3.1% on Australian dollars (1 month deposit) compared to 0.2% on Singapore dollars. However, they have to consider the spread of 1.7% in converting to Australian dollars and back. The higher interest rate is taken away entirely by the spread for short time deposits.

You can reduce the spread to 0.1% by investing in Australian dollars through the forex trading market. For example, if you wish to invest in AUD 50,000 you can buy the same amount in the forex market. Although you have to put in a margin of only 2%, i.e. AUD 1,000, you can keep the remaining 98% of the invested sum in Singapore deposit and enjoy the same investment result.


Hiei said...

True, however, but do take note the below:

1) FX brokers also make a bit out of your daily rolls. Esp, if you are doing the mini's, they tend to eat quite a lot on your daily rolls. E.g, they might only pay you 2% on aud, and you pay 1% interest on sgd, so end up you are only profiting 1% of interest. Just an example, it all differs from broker to broker.
2) risk of margin tradings. Your position will be liquidated the market falls below your equity levels.
3) crosses like AUD/SGD are not really that popular, they may have quite a wide bid/ask spread.

Createwealth8888 said...

Any concerns on margin calls and how to deal with it?

Anonymous said...

Dear Createwealth8888

One will get a margin call only when you overtrade. With proper money management and discipline, there should not be a margin call.

To illustrate, if one pumps in US$500 capital, he/she can set the stop loss per trade to only US$50. US$50 is the maximum one is willing to risk per trade.

Therefore if one trades only 1 mini-lot per trade, he/she can only risk US$50 which is roughly equivalent to 50 pips.

As the forex market is very liquid, the stop loss of 50 pips will 99% be triggered. Once triggered, the US$500 capital is reduced to US$450 and so forth. The only 1% chance that the stop loss is not triggered is when there is a major sudden event like the 911 and the Non Farm Payroll annoucement on the 1st Friday of each month around 830 EST

Even when one receive a margin call, one can choose not the heed the margin call and let the broker close at the current price. This way one does not pump in new funds and top up a losing position

The danger of forex trading is one gets greedy and over-trade, since you are trading on leverage. it is like using borrowed money. When one receive a margin call, it is too painful to close the position as once closed, it is realised loss. He/she pumps in new funds only to find another margin call the following day

Therefore to deal with margin call, one just need to know how much he/she can afford to risk per trade and to practice money management and discipline

But if one is not able to control his/her emotion (fear and greed) and more importantly, too painful to cut loss when the stop loss is triggered or receive a margin call, it is better not to trade forex. One is not different from a gambler


Anonymous said...

i think to invest in foreign currencies, these are some ways

1. Open a foreign currency fixed deposit from a bank
2. Buy from the money changer
3. Trade currencies options through a broker
4. Trade the spot currency through a broker

In my opinion, investing in (1), ie open a foreign currency fixed deposit, is not sound. Consider this
1. The bank will transfer all the currency flucutation risk to the depositor while it takes 0 risk
2. Whether you profit or lose, the bank has already profitted by way of transaction/admin/management fees
3. The bank officer who sells you the above most likely know nothing about foreign currency but merely got some 1~2 hours of training from his currency specialist, just to accumulate the CPD hours and enough to spew out some technical terminology and colourful charts to put forth an impressive presentation

In comparison, Option (2), ie buying from money changer is a better option. However the exchange rates is not very good, and the spread is very wide. You must be able to hold on for very long and the currency pair must move very much in your favor before you can make money. In addition, it does not operate on leverage, meaning you have much less "capital" to start off with

Not too sure on Option (3), forex options. Sound very risky

Option (4), trading in the spot market needs education, money management and discipline. The interest that you are entitled goes mostly into your pocket. Whatever the interest the bank can promise you to earn, you can earn just as much if not more by investing in the spot market through a broker! (So why bother with a FD in the bank?). The spread is much lower and you can trade on leverage. Eg the spread for EURUSD is only 1 pip. No commission etc. If you buy at 1.4000, all it takes is for the currency to move to 1.4001 and you are break even. Considering EURUSD moves an average of 70~100 pips per day, the movement of 1 pip is easily achieved

If unsure, it is better not to trade forex. If one needs foreign currency, i think it is better just to buy from the money changer when one needs it


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