You would like to increase your emerging market exposure but you need a simple and effective way to invest. You like the security and accessibility of cash but you need an average rate of return better than what Treasuries can return in this zero interest rate environment. You love the growth in your equity portfolio but need access to uncorrelated returns when things turn south. The foreign exchange market, or forex, answers many of those needs and is the largest financial marketplace in the world.
For decades the forex market has been known as the market that determines exchange rates. In other words, the buying of one currency and selling of another as an efficient means of determining supply and demand. With central banks around the world granting only limited access, forex investments were difficult to access for everyday investors. This has changed dramatically. What was once a market dominated by major banks and investment firms is now the largest trading and investing community in the world.
Here are 10 reasons why forex investing is an important part of any portfolio.
Despite the low 0.12% rate of return that many money market funds provide, cash has remained the center of the universe for many investors who seek the security of the dollar. A study conducted by Bankrate in July 2013, showed that more than 25% of Americans stash their money under the metaphorical mattress (see “Is cash king?” right). Alternatives exist. Investing in the FX market allows you to maintain the security of cash while potentially benefiting from higher interest rates provided by other countries’ central banks. This can be done by the investor through a self-directed account and a little financial education, a broker-assisted account or a managed account through an investment with a commodity trading advisor (CTA) who specializes in FX trading.
With the interbank forex market capturing approximately 95% of the almost $5 trillion traded in G10 currencies, it provides the liquidity needed to execute trades seamlessly (see “Rivers of liquidity,” right). This means that traders are seldom caught in positions that they cannot liquidate. While providing the volatility and price action sought by traders and money managers, it is this ability to seamlessly exit positions that make the forex market stand out. Higher volume also has the tendency to translate into lower transaction costs, ultimately amounting to higher returns for market participants.
Congress passed legislation in 2000 and 2008 requiring firms acting as counterparties to retail forex transactions, as well as forex pool operators, CTAs and introducing brokers to register with the Commodity Futures Trading Commission (CFTC) and become members of National Futures Association (NFA), the self-regulatory organization for the U.S. derivatives industry. While there are good and bad sheep in any market, the forex space has had greater problems due to a lack of oversight in the past but now has greater supervision.
FX traders, whether in futures or the spot market have visibility into their account at all times. Whether they maintain accounts in their own name, at a bank or futures commission merchant (FCM), the underlying structure is the same.
5. Market access
If there is a bank open in the world, chances are the forex market is open. It is a large, growing and liquid financial market that operates 24 hours a day, five days a week. It is not a market in the traditional sense because there is no central trading location or exchange. Most of the trading is conducted through electronic trading networks, permitting market participants to react to economic events and currency movements.