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‘I run an online share trading platform and I don’t consider myself a forex trader. In fact, I would not want to try make a living out of forex,” says Brett Duncan, the head of retail equities at Standard Bank.
He says that the marketing of forex trading as a way to get rich quickly is misleading.
Foreign exchange as an asset class is important because it is the most liquid and largest market, and is how money is transferred around the world.
A bank may, for example, buy and sell forex for a large importing company; the same company may be placing a large product or service order that has to be paid in a foreign currency in a month’s time and will then use forex trading as a hedge in case the rand weakens and increases the end price.
Forex trading can also be used as part of a trading strategy where your portfolio may be overexposed to one currency and you wish to diversify, or if you believe that a currency will devalue due to political or economic events.
The concept of forex trading as an investment strategy within itself has to do with the ability to gear one’s position to become one where a small movement in the currency can result in a large gain.
Say, for example, you have R10 000 and want to take a position that the rand will depreciate against the dollar.
The exchange rate is R13.50 for $1, so your R10 000 buys $740.74. If the rand falls to R14 to the dollar, your $740.74 will buy you R10 370.
On a one-to-one basis, if you bought the actual currency, that would give you a profit of R370, but, with gearing, you buy exposure to the movement of the currency, not the actual currency.
As you are only buying exposure to the currency, the broker can offer you a leveraged position where, for example, your R10 000 gives you R100 000 worth of exposure.
In this example, your rand exposure increases from R100 000 to R103 700m so your profit is R3 700. You only physically invested R10 000, so that equates to a 37% return.
If the rand strengthened to R13, your loss on R10 000 is R3 700 – more than a third of the value of your initial outlay. If the rand suddenly strengthens to R12.50, you can wipe out nearly 80% of your entire investment.