TIP: Investors must have confidence in a risk/return relationship

Speculative currency trading is a high-risk/high-return game. Currency investing diversifies this risk by taking many different positions in many different exchange rates. The risk/return characteristics of currencies are different from other asset classes and among individual exchange rates.

The volatility of major currency pairs, such as EUR/USD, is typically less over the course of a year than the volatility of the S&P 500 Index. The problem is that investors look at short-term volatility and use that as a general measure of risk. That won’t work for currencies as an asset class.

If all forex participants were speculative traders, the story would be different. But they’re not. The majority of forex trades are made not to bid up prices but to cover outstanding positions and otherwise maintain stability.

Positions are taken based on many different perceptions of the market—using strategies that include technical analysis, economic indicators, interest-rate differentials (the “carry trade”), and derivative plays based on emerging as well as major currencies. This multiplicity of “currency views” enhances the natural diversification effect of currency investing.

In the short term, there may be no easily defined relationship between risk and return in forex. Over longer periods, however, valuation trends are slow to change, and it is possible to take advantage of established flows. Read more

Do you want to learn more?

VIDEO: MONTHLY WEBINAR: Exploring the Coast Line of Foreign Exchange Land - Part I - Gonçalo Moreira
VIDEO: MONTHLY WEBINAR: Exploring the Coast Line of Foreign Exchange Land - Part II - Gonçalo Moreira
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