Highlights in this issue:

*** Better than equity investing? You bet…
*** 4 Advantages of forex trading…
*** Interested in getting involved, make sure your name's on our list…

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From the pen of Karin Iten…

Dear Investment Academy Reader,

You’ve been asking a lot of questions about different types of investing lately. One of the questions I recieved recently is: "How does the average trader or investor buy and sell currency?"

So this week, I asked two currency experts D. R. Barton and Tapiwa Karoro to share the most common and accessible ways of trading currency… and which instruments might be the most useful for your portfolio.

Here’s what they had to say…

The best way to trade currency movements

Whether you think the rand will go up or down, if you want to trade or invest in it, you must have something to buy or sell. You could always run down to a bank or an international airport and exchange all your rands for dollars, or vice versa. But as anyone who has traveled to a foreign country knows, the transaction fees charged by banks or currency exchange kiosks are huge!

Thanks to the highly speculative nature of this market, currency price movements tend to overshoot and then retrace. This makes it easier for technically inclined traders to identify new trends or false breakouts. And, as such, be able to choose the best entry and exit points.

Despite the volatility, currencies – unlike equities and other commodities – seldom trade in tight ranges or move sideways. This means price movements tend to be predictable. They create strong trends, which are easy to read. And this makes trading much easier.

“Why are currencies so volatile?” you ask. Well, forex is the largest and most liquid financial market in the world. Before the current recession began in 2007, the average daily trading volume in the forex market was $1.9 trillion. At present, daily trading volumes average around $1.4 trillion. That’s huge when you compare it to the $50 billion and $30 billion traded daily in the equity and futures markets, respectively.

This means the forex market can absorb massive trade sizes. There’s almost always a willing buyer and seller in the market. This gives you the flexibility to enter or exit the market and means you’re unlikely to get stuck in a trade like you can be when you trade illiquid shares.

The size and the liquidity of the forex market also adds to its transparency. The large quantities traded make this the most transparent and most efficient financial market out there.

Even better, it means the market’s too big for one party to corner it. Even when central banks and governments intervene, the market returns to equilibrium quickly. The benefit of such high levels of transparency is you can implement your risk management strategies in line with appropriate fundamental and technical indicators. This transparency also lends itself to tighter bid-offer spreads (the difference between quoted buying and selling prices). This means there’s a higher probability of order execution and fill confirmation – which is crucial for your profit potential.

So, let’s look at the best alternative within the strategy of currency trading…

You can trade the rand through the JSE YieldX currency futures contracts. Currently, the YieldX offers contracts in four currencies versus the rand –namely the dollar/rand, euro/rand, sterling/rand and Australian dollar/rand.

To trade these contracts, you have to open an account with a futures broker. Here are some pros and cons to futures trading:

• Advantages: Well-regulated, sufficient liquidity, highly leveraged, low transaction costs.
• Disadvantages: High leverage brings greater risk, so you have to keep up with expiring contracts.
• Bottom Line: Leverage makes this an instrument for seasoned and disciplined traders and investors; however, for those who have the experience and skill, this is the way to get the best bang for your money.

How does it work?

Well, basically you trade a currency in pairs, for example the dollar/rand cross (USD/ZAR) or the inverse rand/dollar cross (ZAR/USD). This means the one currency (the US dollar or USD) is priced in relation to the other (the rand or ZAR) in the case of dollar/rand cross.

So, when you buy the cross, you, in effect, buy dollars and sell rands at the same time. When risk aversion is rife – as was the case less six months ago – a good trade was the dollar/rand cross – long dollars (buy) and short rands (sell).

However, as signs of recovery emerge and risk aversion wanes, you should sell the dollar/rand cross – short dollars (sell) and long rands (buy). This is the same as buying the rand/dollar cross. In essence, as the market moves, one currency will rise, while the other falls. This means you have an equal opportunity to profit in a rising or falling market as long as you choose the correct currency to be long or short.

Happy trading,

D.R. Barton, Jr and Tapiwa Karoro
For the Investment Academy