wealtharticles-how_to_profit_from_the_forex

How To Profit From The Forex Market?

So you want to buy a foreign currency and bet it will go higher, hoping to reap a handsome profit. Citibank Singapore's head of wealth management, Mr Salman Haider, says forex trading represents an investment opportunity under two scenarios.

One is you have a direct financial need. For example, your children are going overseas to study and you need to pay school fees and living expenses in a foreign currency. The other is if you are speculating or investing with a view to earning a yield that is better than interest rates in Singapore.

For speculators, the best opportunities lie in the most commonly traded (and thus most liquid) curencies, such as greenback, yen, euro, pound sterling, Swiss franc or Canadian dollar.

1. Buy low, sell high
You buy or sell currencies with the objective of earning a profit by closing your position. For example, if you buy a currency and it appreciates, then you earn a profit by closing your position.

The simplest way to do this is to go into a bank and open a foreign-currency fixed deposit account. Then you wait, hoping the currency you have invested in will strengthen against the Singapore dollar so you can earn a profit.

you can also open a dual-currency account, you get potentially higher returns, and you can opt to have your principal and interest paid to you in either the base currency or the alternative currency. Depending on your investment strategy and market conditions, an exchange rate for the two currencies will be determined and agreed on between you and the bank.

You will make money if the base currency (typically, but not necessarily, the Singapore dollar) weakens against the alternate currency. If the reverse happens, you'll probably make a loss. Your principal and interest will be converted to the alternate currency at the pre-agreed exchange rate. The loss could widen if you choose to convert your money back to the base currency.

Note that currency movements can be affected by many things. Monetary policies, economic performance, interest rates, inflation rates, market sentiment, central bank intervention and even natural events all affect currency exchange rates.

2. Join the carry trade
In the carry trade, investors borrow low-yielding currencies and lend high-yielding ones. The classic driver of forex is interest rates. If one currency has a higher interest rate environment and another has a lower interest rate environment, there may be demand for clients to move out from the latter to the former.

For example, with interest rates in Singapore currently at around 0.2%, it seems beneficial to borrow in Singapore dollars and park the money in currencies such as the Aussie dollar, with interest rates in Australia at about 6.5%, or the Kiwi dollar, with rates in New Zealand at about 8%.

Interest rate differentials, especially if the foreign-currency interest rates are higher, are attractive from the single perspective of interest rate yields. The main risk in carry trading is that forex rates could change so sharply that the investor would have to pay back more expensive currency with less valuable currency.

Carry trades are particularly susceptible to unwinding in times of market distress and high volatility, says Mr Emmanuel Ng, a forex strategist at OCBC Bank. Note that high-yielding currencies like the New Zealand dollar may have inherently higher hostorical and market-implied volatility.

Put another way, exchange rate fluctuations can either add to or subtract from the returns on your initial sum. In the worst-case scenario, the foreign price could drop so far that it would eradicate more than the interest rate yield on the principal. You would suffer a net loss on your investment.

However, in cases of currency pairings where the interest rate differential is high - it is, for example, about 7% for the Singapore dollar versus the Kiwi dollar - it would take a lot for the potential yield from the difference to be eroded. Still, investors must be aware of the risk that it could happen, no matter what the percentage of it happening is.

In the medium to long term, investors should evaluate a currency based on its fundamentals.

By, Michelle Tay, The Sunday Times, 4th May 2008.