Before we answer this question, let’s see how one can lose money in FOREX (Foreign Exchange Market – FOREX) – International Foreign Exchange Market. The birth of FOREX should be credited to the American president Nixon, who renounced the conversion of the USD into gold. As a result, due to budget and trade deficit in the US, the US dollar could no longer serve as an international currency.
The renunciation of gold standard put an end to Bretton-Woods Agreement and ‘fixed’ rates of the foreign currencies against the US dollar. The subsequent cancellation of the restrictions against free capital flow among the countries, along with the floating currency rates, allowed the investors and financial institutions to acquire a new ‘playground’ for their future endeavors. Daily capital turnover in FOREX is USD 1.2 billion (2005), which is 40 times bigger than NASDAQ’s stock exchange turnover.
How is the game in FOREX trading organized? It is organized around international trade. Let’s assume that a certain Canadian company (we can conveniently name it Canacs) sells Canadian lumber to Chinese company (we can conveniently name it Chinacs). The Canacs Company undertakes the delivery of 400, 200 and 300 hypothetic units of lumber to Chinacs in May, June and July. There are possibilities of different provisions to this contract. Let’s assume that the contract states the price on lumber in CAD. Hence Chinacs has to pay to Canacs in CAD during established period of time. Chinacs will be selling lumber in China for Chinese money. This means that during the repayment time outlined in the contract, Chinacs will have to undertake the risk of buying the Canadian dollars at a rate they do not know yet, or acquire the rights of purchasing the Canadian dollars at reasonable and favorable rate. The bottom line is that many international trade agreements follow the same pattern. Do the trade companies face risks when conducting such operations with FOREX? Absolutely not! All other currency exchange market players represent the interests of trade companies; they provide them with counter trade deals and incur the risks.
Who are the other currency exchange market players? They can be divided into two categories: financial institutions and individual investor-players. Who represents the financial institutions? Professional traders who have been representing a certain bank or a company for number of years and have solid educational background, experience and million dollars worth technical and information to support them. Do they stand a chance of losing the money? Yes, they do. They might fail once or couple of times before being replaced with another, more successful, trader.
Another category of market players is represented by individual investors-speculators. They came to FOREX, on sites like FXCM.com, in order to get rich, to make a hypothetic ‘million’. Someone has bought a ‘magic system’ that guarantees regular success in trading, while the others just decided to give it a try. In other words, people are motivated by the similar notions that the casino gamblers have. In order to really make some serious money, this category of players has to buy a forex shoulder: 1:20, 30, 100, or borrow the money with interest. Do they stand a chance of earning money? It equals the same of a professional trader to lose the money.
The FOREX game is called zero-sum game, which means that if someone wins, another one loses. For example, and rather theoretically speaking, anyone can make money in stock market, whereas in FOREX it is only possible to win if someone else loses. The answer to the question as to how not to lose money in FOREX is obvious: this kind of a game cannot be viewed as an investment. It is a speculation. For investment purposes you should use investment funds (some of them work in conjunction with FOREX).
FOREX is an activity suitable for professionals only, namely for companies that specialize in foreign trade and for individuals who had fallen victims to gold rush concept or promises of miraculous earnings in a game where one is an a-priori loser.
Courtesy of our partners who have history of 150 years of being successful in business, if you need to exchange currency, you can do it easily online by direct accessing the market. The registration is here or on the main page of the aforementioned website. You can ask your questions right under the article posted on the website.
Michael Arbetov, CFP, FMA
Financial Advisor
Note: This article was first published in August 2005 and has been re-posted numerous times on various websites and forums without my consent.