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Playing the FX market may look like the way forward in 2023 but don’t believe the hype. Buying and selling foreign currencies through a low-cost intermediary is your better bet.

Boon Tiong Tan reports

2022 was a year when many Hong Kongers felt the pinch, as bond, stock and property markets all headed south. However, there was a bright spot – the US dollar (USD) strengthened significantly during the year.

In September, the British pound (GBP) almost crashed to parity (GBP1 = USD1) and in October, the Japanese yen (JPY) broke JPY150 to USD1. With the Hong Kong dollar (HKD) pegged to the US dollar, HongKongers continue to benefit from a strong US dollar moving into 2023. This means overseas properties are more affordable and tuition fees at foreign universities are cheaper.

We have more spending power as tourists in Thailand, Japan, the UK and many more countries. The currency or foreign exchange (FX) market has an impact on everyday life, and it’s the biggest financial market in the world, bigger than both bond and stock markets.

It is conducted electronically over the counter, which means that all transactions are done via computer networks among banks and other players, rather than on a centralised exchange. The biggest centre for FX transactions is London, followed by New York and Singapore.

For decades, before it was trumped by the nonstop, 24/7 crypto currencies market, the FX market had by far the longest trading hours in the financial markets. It is a 24-hour market that star ts trading on Monday morning in New Zealand and ends on Friday evening in New York.

The FX market has been touted as an asset class just like stocks, bonds and commodities. With both stock and bond markets tanking this year, should you diversify and invest in foreign currencies, or even trade them?

The developed countries’ currencies tend to move in large waves and take years to move a third or more. If you were to put 10% (probably the highest percentage a prudent financial planner would recommend) of your assets into the right foreign currencies, your portfolio’s return is not going to improve much. Worse still, you might pick the wrong currencies and suffer losses.

If you’re convinced by some experts, advertisements and websites that it is not difficult to pick the right currencies and time the FX market, think again. George Soros, the billionaire hedge fund manager, who in 1992 made a billion US dollars by ‘breaking the Bank of England,’ wrote that while the stock market has two variables, the FX market has seven or eight. The FX market is undoubtedly much more complicated than the stock market.

Which fundamentals or variables affect the FX market? The GDP, interest rates and trade balance are some of the obvious ones. What’s not so clear
is which ones are more important at a certain point of time and how they affect a currency’s value. The fundamentals that FX traders focus on are a
moving target. There are times when traders pay attention to interest rates; there are times when they watch trade balances closely; there are times when they focus on political developments. No one knows when the focus will switch, and it’s often not immediately obvious that a switch is happening.

Sometimes there’s no clear focus on fundamentals at all. Instead, the market concentrates on other issues, such as technical support or resistance, or where the big stop-loss orders are. To complicate things further, a currency’s value isn’t determined purely by its country’s fundamentals.

It has to be measured against another country’s fundamentals. It’s all relative. If the FX market is too complicated to make a calculated and intelligent investment, how about trading it? Maybe there are some short-term opportunities?

Many FX experts and trading platforms would like retail investors to believe that FX trading can be profitable. They highlight its 24-hour market, deep liquidity, narrow spread and easily available leverage. Let’s take a look at each of these advantages to see if they stand up to scrutiny.

How does the 24-hour market benefit FX traders? It allows them to react to real-time news. The assumption is the faster we can react, the better. However, as a professional FX trader, who spent two decades staring at FX prices for many hours a day and got the latest news faster than most retail traders, I have concluded that this is a fallacy. It’s really hard to know how the FX market will react to news. Sometimes the market reaction can be violent to start with and then reverse just as quickly. Other times the market hardly moves, even though you think it should. The possibilities are numerous but you get the picture.

The main FX players, like banks and funds, trade in millions and even billions and benefit from the most liquid financial market in the world. However, this deep liquidity is pretty irrelevant to retail investors who trade in thousands to hundreds of thousands of dollars. A small fish doesn’t do well in a big pond. Another so-called ‘advantage’ for FX traders is how the thin spreads between the buying and selling prices of currencies lower transaction costs. This is true but the savings are very tiny unless you make many trades daily.

In the FX market, a move of 20% in a year is considered big but that’s nothing compared to stocks which can move hundreds of percent. To beef up the returns, retailers and institutions alike are encouraged to use leverage, up to 100 times the account balance.

With US$10,000 in your FX margin account, you can buy and sell US$1 million worth of currency, which is extremely dangerous. While a 1% move in your favour doubles your money, a 1% move against you will wipe you out.

The so-called advantages of FX trading tend to encourage over trading. The key question isn’t about these advantages, it’s about whether the FX market
offers a good chance to make money. Truth is, funds that exclusively trade FX regularly per form worse than stock and bond funds – and this is despite their using leverage. It is very rare to find a top investor who trades FX exclusively. The top investors, like Warren Buffett and George Soros, know that good opportunities are rare in the FX market. It’s too complicated to trade actively and profitably.

While you may decide against investing in foreign currencies or trading the FX market, you will still need to buy foreign currencies to send overseas. Many people continue to go through banks where transaction costs, like fees and spreads, can be more than 1%. Nowadays, however, there is a cheaper
way – working with low-cost FX intermediaries.

Consider that Interactive Brokers, a popular financial products trading plat form, enables its clients to buy and sell foreign currencies for a small fee and with the narrowest of spreads. You can even leave an order to buy or sell currencies at your desired price. Wise, one of the biggest online FX-transfer companies in the world and listed on the London Stock Exchange, offers an average transaction cost of 0.6% and a fast transfer to an overseas account.

Going into 2023, whatever you need from foreign currency – whether you want to travel more, invest in proper ty overseas or pay tuition fees in foreign universities – there are two things you need to know. FX investing and trading are likely to lose you money. Buying and selling foreign currencies through a low-cost intermediary is surely going to save you money.

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DB resident Boon Tiong Tan (CFA) has worked as a trader with banks like HSBC and Morgan Stanley for over 20 years, and he is the author of A Stock Investment Book for The 99%.

For information about the one-on-one courses (money management, stock investment, options trading and chess) he provides for both adults and kids, email [email protected].

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