Tan Kin Lian's Blog: Gambling on foreign currency

Wednesday, September 09, 2009

Gambling on foreign currency

If you buy foreign currency, you are gambling on its exchange rate in the future. If it goes up, you make a profit. If it goes down, you make a loss.

If you lose on your position, you can decide to hold to that position, and hope that it will recover. It may recover or it may get worse (and increase your loss). This is gambling, so it is better to recognise its nature and think like a gambler.

It is all right to gamble, provided that you get the full benefit of any upside, and take the full loss of any downside. Make sure that your cost of the transaction is small, i.e. less than 0.3% for each side of the trade. The cost is the spread between the buying and selling price at the same time, and the additional charges that you have to pay to the bank.

There is another type of gambling that you should avoid. Do not gamble when the odds are loaded against you. If you gamble on a card game, do not gambling against a shark who has marked cards. He has superior information and is likely to win against you.

Similarly, you should not gamble on dual currency trade when the terms of the transaction are set by the bank who is taking the other side of the trade. You can be sure that the terms will be loaded in favour of the bank, who makes a profit when you make a loss.

One year ago, the Australian dollar dropped 30% against the US dollar over two weeks. The investors who were "long" on Australian dollars suffered a 30% loss. Those who were "short" on Australian dollars did not benefit from a 30% gain. They only get 2% or 4%. The rest of the gain goes to the bank who wrote the terms of the dual currency trade.

Are there circumstances where the bank will lose? Maybe, but the risk is small for the bank. They employ financial engineers to set the terms of the trade. These financial engineers look after the interest and profit of the banks. Guess who loses?

In some countries, the regulators ban this type of product as it is unfair to retail investors. But there is no such scrutiny in Singapore, so retail investors can be given unfair terms of the trade, i.e. "taken for a ride".

Lesson: never gamble on exotic products where the terms are written by the other party of the trade.

Tan Kin Lian

14 comments:

Anonymous said...: Hello REX has a question for you sir.
I am wondering whether those advertisements that claim that you can make millions and retire young by being a Forex trader,has any merits? Recently i see a lot of such enticing advertisements that give the impression that if you know the "secret" you can live life off by playing with foreign exchange.
I thought that the regulator ought to have some control over this situation, if forex trading is not as simple as advertised in those advertisements. How many people actually got burned and how many actually really benefitted from those courses run by the trainers, i wonder. It will be very interesting to hear some feedback from anyone who attended those training sessions.
REX; September 09, 2009 9:13 AM
Anonymous said...: The dualo curency trade is not transparent to the retail investors but if you are disciplene, you can invest in them. That is what I did.
1) I decided to invest in foreign currency after I have taken a view of the country's economy, the rate of exchange and interest rate differential. I have also decided to invest for a longer term period of few years to ride out the cycle.
2) The the decision is whether to do a straight buy versus the dual currency mode. The dual currency mode normally offers a better interest rate and excnage rate than a straight buy conversion for a retail investors. Then you lock in.
3) If you did not get converted, use the above rule again.
4) If you get converted, it depends on what the bank offers you on paring back.
5) I did that for 4 months then the rate went way off. That is the time you stay with the converted currency for the long term that you started off. Do not continue to play as you would loose your shirts.
6) I suffered a paper loss of 25% but today I am breakeven in local currency term. But if the intention is to ride the cycle, then the movements do not affct you much in the meantime as:
a) you got a better exchage rate when you were converted.
b) You get a super high interest rate for a few months than you would above the normal foreign currecy deposit.
c) you continued to get a higher deposit rate than local rate.
you then wait for the cycle that you believe when you take the position.

Most peole lost money when they continue to pair when the bet moves against them. but if you are disciplined, you can take some advantage of it.; September 09, 2009 9:24 AM
Anonymous said...: Recently Australia dollar dropped 30% against American dollars-- Is this correct? Quite the contrary, Australia Dollar has risen against US dollars!; September 09, 2009 10:05 AM
Black Fingers said...: I think I saw an article few days ago about trading in forex and making abt 10k a month. Maybe true for very few people but dont be mislead by any of these articles as for every winner, there are many many more losers. Rule of thumb, "invest" only with money which you may lose 100%. Even so, why take this risk. Too many adverts on how to make money even in negative markets. I wonder how many people really make money. You only read about the successes but never the failures.; September 09, 2009 10:07 AM
Anonymous said...: My thought on the above:

I) Fixed currency deposit should be ok. 9 months ago I bought Aus at 1.03 and sold recently at 1.20 in DBS FD [foreign]. Also earned some interest. This is straight forward without much complication. Right now, nothing seems attractive as all currencies are stronger than US$ & interest rate is very low.

II) If financially educated properly, trading Forex on your own is challenging as commission is based on the spread. Again, you must demo trade for at least 3 months. IG marketing website allows $100,000 demo trade. Also good to attend a course ranging from $600 to $2,600 depending on your preferrence.

I think the above has very minimum bank involvement but you have to get enough financial education on (II). Discipline and a strategic plan is needed to ensure you don't get burn by leverage.

Just my thoughts.; September 09, 2009 11:48 AM
Anonymous said...: The audience of the "Earn a living thru trading" seminar probably do not get sure-win from the market. But one thing for sure is, the organizer of such seminars sure win big from the hefty fees the audience have to pay to attend.

Also, I attended a SGX organized derivative & forex class sometime ago. The trainer is a CEO from a local forex trading company. He explicitly told us he wishes to educate more people on derivative/forex trading so that more people will use his company's service. That's how his company earns money through commission.; September 09, 2009 12:09 PM
Anonymous said...: if things are so easy, nobody need to work. well those who are selling the "secret" are not working because of the pigs who buy the secrets; September 09, 2009 12:14 PM
Anonymous said...: Dual currency trading should be regulated. This product is dangerous to the general public and should be banned from being peddled altogether.

Why did MAS allow such harmful products to be made available easily to the public?

What if there is some unsuspecting elderly folks decide to park some money with this product because the bank officers told them that it is safe? It will be a minibond saga all over again.

All such risky products should be taken off the market and confined to the region where the sun does not shine - probably in some cell where all the financial engineers huddle together and gamble with one another.; September 09, 2009 1:33 PM
Anonymous said...: Every time you hand your money to another person to take care or hoping he increases your money value, risk is always there i.e. the person runs away, the downside never explain properly, the company went bankrupt etc.

After MB, the only person I trust is myself. Not Banks, not FI, definitely not MAS.

I cannot to trust Fund Mgrs, FAs or RMs anymore as they are all out to earn a commission and in the event of misrep, their company throw the book at you. The regulator will just tell you "Not my problem"; September 09, 2009 8:30 PM
Anonymous said...: If you want to trade FC, just go to money changer to buy without any commission. Sell it when the rate is in you favour. Eazy as that!!!
You kept the money yourself in your house or SDB.; September 10, 2009 10:09 AM
Anonymous said...: I have been investing in dual currency investments for 5 years. It has been profitable for me as I am seldom converted to the alternate currency. I strike far from the spot exchange rate (200 to 400 pips away), and when I get converted to the foreign currency, I do a reverse strike until I get converted back to SGD, with a capital gain or at breakeven. Otherwise, I stay in the foreign currency call/FD account until I can do reverse strike.

One should take a view on a foreign currency *after* doing sufficient research (studying analyst reports, reading financial news, looking at economic indicators like GDP, employment, retail sales figures etc, looking at average trading range of the currency pair...).

Also, one needs to be prepared to have a holding period of up to 12 months to account for possible conversion to foreign currency and eventually converting back to SGD not at a loss (if one cannot wait that long), but at a profit (from interest rate and capital gain).

As for interest rates, check around to get the best quote.

Dual currency is not a gamble if people do their homework and have a long holding period. In fact, I find forex easier to trade than stocks as I can make money from forex in both bull and bear equity markets.; September 10, 2009 10:27 AM
Jerome Tan said...: Foreign currency is very volatile, this gives rise to many opportunities to make profit or loss

If one has proper money management and discipline, one may be classifed as "trader". lacking either of these two, one can be termed as gambler.

If foreign currency suits your appetite, i think you are better off to trade yourself directly. You only pay the spread (with the exception fo Philip Securities which imposes commission in addtion to the spread). The spread is quite acceptable if you trade the major currency.

Financial education is critical. I have been to many of the courses but find it quite useless. There is a lot of good educational materials from the internet. Take time to search the internet instead of attending the courses

However if you invest in foreign currency fixed deposit, chances are pretty high that you will lose out; September 11, 2009 1:41 AM
Anonymous said...: The banks are there to make money. Lesson is never trust "professional" bankers, they are "professional" in making your money, not making money for you. How many of their advice comes from true and sincere research and experience? They sell only because someone on top pushing for sales and the sellers don't know what they are selling.; September 11, 2009 8:01 PM
Anonymous said...: My accounting job requires me to track the ex-rate. Most (if not all) of the time my forecasts were always right. (Not my money!!)

I rely on simple logic. When major currencies hit real bottom/apex, it will have to move in opposite directions at a certain time frame, with reference to the political, agricultural, industrial, economic situation.

However, I had refrained from investing in forex because I keep my job and personal life separate.

I have a tidy sum in my kitty bank but mentally I know I cannot afford to loss my hard earned money.

My risk profile: Conservative.
This is to emphasise that education/occupation and personal risk appetite do not move in the same direction. (No correlation)

To all potential forex investors, you really have to do your HOMEWORK before entering into any deal. Understand your risk profile and trust your "gut feeling" . That's it.

In this instance, we must truly admit that there is no such cases of being "misled" should we loss in forex.

Hopefully your bets will be as good as mine.

(The irony of this is, instead, I sincerely relied on a RM's recommedations and invested in minibonds and pinnacles.)

The morale of my story, "don't trust anyone except yourself".; October 04, 2009 2:06 PM