From mid-July to late August 1998, the major stock market averages dropped about 20%, generating headlines and massive concerns among investors. With less fanfare, the investment community witnessed an even greater market move. It began last July and continued into January. The Japanese yen rose 35% against the U.S. dollar.
When such fluctuations occur, there are winners as well as losers, creating opportunities for disciplined investors to profit. What’s more, currency trading isn’t correlated to the stock market, so it’s possible to register gains even when the Dow drops like a stone.
How can you participate? By trading currencies, which might include the yen, the Swiss franc, the British pound and the new euro, among others. The risks can be enormous, though, so you need to know the rules before leaping into the game.
For the individual investor, gaining exposure to currencies usually means dealing in futures contracts, which are traded on the Chicago Mercantile Exchange (www.cme.com). “With futures contracts, you can go short as easily as you can go long,” says Ken Steben of Steben Asset Management, Rockville, Maryland. That is, you can bet on a decrease or an increase in a currency’s value.
Currency trading involves the use of “margin,” a “good faith” investment an investor must put up when buying or selling a futures contract. This process substantially raises the stakes. “A euro contract worth more than $138,000 might be acquired for only $3,000 in good-faith money,” says William O’Grady, vice president at A.G. Edwards, a brokerage firm in St. Louis. If the futures prices move adversely, the investor must put up more money to meet margin requirements.
“In currency trading, you need to control your risks while setting targets that can offer large rewards,” says Keith Raphael, president of Crosscurrents Investment Advisory in Danbury, Connecticut. “Knowledgeable traders try to hold losses on each trade to 1% or 2% through stop-loss orders to their broker.” Through a stop-loss transaction, the customer orders his or her broker to set the sell price of a security below the current market price in order to protect profits or prevent losses if the value of the security drops.
How can you be among the triumphant 10%? Here are some tips for investing in currencies:
- Start with a sizable stake. “Many individuals are undercapitalized,” says York. “Although you can trade currencies with as little as $3,000, I’d put $10,000 as the minimum necessary. You’re better off with $20,000 or more.”
- Follow the markets. Informed investors will know, for example, that this year Japanese officials have been trying to “talk down the yen” to reinflate the Japanese economy. “Make sure you effectively use both fundamental and technical analysis,” says York. “Don’t invest on hot tips.”
- Plan ahead — and stick to your plan. Learn the lingo of the futures markets so you can use different types of orders properly. Always calculate an exit price once you have entered a new position. “The greatest mistake made by currency traders is to let losers ride while cutting their profits short,” says O’Grady. “They should