Any American who's traveled abroad in the last few years has probably noticed that the greenback buys less than it used to.
Currency market followers attribute the buck's weakening mostly to the obvious suspects, including an escalating U.S. trade deficit, government debt and soaring oil prices. When a country spends more than it takes in, logic dictates its currency ought to fall.
But the dollar's performance involves more than a rational response to economic data. It fluctuates at the whim of a group of highly stressed humans known as currency traders. Each day, traders wager trillions of dollars on oscillations of national currencies, making instant trade decisions in response to factors like unemployment numbers, commodity prices or a perceived twitch in Alan Greenspan's left eyebrow.
These days, it's not just banks, multinational corporations and Warren Buffett who are placing fortunes in foreign exchange, or "forex," markets. Individual investors are getting involved, employing desktop trading platforms that operate in much the same manner as online stock-brokerage accounts.
With a broadband connection, a few thousand in cash and the emotional stamina to withstand losing said cash, anyone can trade foreign exchange. It needn't even interfere with your day job. Unlike the stock market, forex runs 24 hours a day.
"It's perfectly suited to night owls, early risers, insomniacs," quipped Glenn Stevens, managing director of Gain Capital in Bedminster, New Jersey, which operates an online forex trading platform.
It's not clear how many individual investors are trading forex. That's partly because most popular forex trading platforms are run by private companies that don't disclose customer numbers.
Unofficial data indicate online forex trading is growing dramatically. Gain and Ada, Michigan-based Global Forex Trading, two of the larger U.S.-based online forex providers, ranked 9th and 16th in a list of the 500 fastest-growing (.pdf) technology companies in North America compiled by Deloitte & Touche. Gain's revenue grew from $95,000 in 2000 to $22 million in 2004, according to Deloitte. GFT's revenue over the same period rose from $249,000 to $39 million.
Electronic foreign-exchange trading volume, meanwhile, has doubled in each of the past two years, according to Greenwich Associates, a financial research group.
Most newcomers to forex already have experience in online stock trading, which makes it easier to follow currency exchanges, said Samantha Roady, Gain's vice president of marketing.
"You can take a lot of the tools you use to trade stocks and use them to trade forex," she said.
If you don't have tools, a plethora of books, online training programs and seminars promise to provide them. Currency trading, like stock investing, has spawned enough how-to-get-rich-quick theories to fill a library of self-help tomes.
Some react to rumors, such as the early reports that surfaced last week regarding the Federal Reserve's plan to soften language regarding interest-rate hikes. Others pounce on actual news, like the release of a Japanese business-confidence survey last Wednesday that propelled the yen to its biggest one-day gain in years against the dollar.
Raghee Horner, a currency trader and author, prefers to ignore the news altogether and stare at charts instead. She plans trades based on the movement of currency charts. If a news item triggered the movement, Horner said, she usually finds out after the fact.
"A chartist like myself feels that all the economic data are represented in the price," Horner said.
Long-term investors, by contrast, commonly analyze whether a currency is over- or undervalued, based on factors like purchasing power parity. This concept holds that identical items sold in two countries ought to cost the same when expressed in the same currency. In reality, however, purchasing power indicators like the Big Mac Index show that the cost of the same goods can vary wildly depending on location. (Want a Big Mac in Iceland? It'll cost you more than $6.)
Whatever tactic one chooses, currency trading promises to be exceptionally risky. This is largely due to the massive amount of money foreign-exchange traders can borrow.
In a typical forex account, a trader can invest 100 times more money than he or she puts in. That means someone who opens an account with $10,000 can trade $1 million worth of currency.
Vast leverage makes it easy to make or lose a lot of money very quickly. If you're a fully leveraged trader, you can either double your money or lose it all if an exchange rate fluctuates by 1 percent.
That kind of leverage is one reason novice forex traders frequently go broke.
"Some people handle it very poorly," said Gary Tilkin, president and CEO of GFT. "Very often new traders get in thinking it's easy money."
Doug Schaff, who runs the forex firm Fx-Strategy, recommends reducing risk by leveraging only a portion of one's account. In Schaff's case, this means wagering about 8 percent of the currency at his disposal.
Tilkin advises newcomers to "trade with play money for a period of time" before opening an account with real cash.
This is relatively easy to do. Both GFT and Gain offer simulated accounts for new users. I opened one Friday morning and wagered $100,000 in fake money that the U.S. dollar would strengthen against the Canadian dollar. (Most platforms offer trading for only a handful of major currencies, so the Icelandic krna wasn't an option.)
Minutes after placing the trade, I watched the profit-and-loss calculator in the corner of the screen go red. My bet almost immediately produced a loss of $50. Thankful it was play money, I closed the screen and put the loss out of my mind.
Checking back a few hours later, my fortunes had improved. The U.S. dollar had strengthened, and my $100,000 wager would net me just over $150 in profit. At that point, I followed my non-gambler instincts and closed the trade.
After all, I considered, betting against the Canadian dollar, or "loonie," has been a losing proposition of late. It's at its highest level in almost 14 years against the greenback. Forex message boards on Elite Trader are abuzz with speculation that the loonie will strengthen further.
I don't necessarily agree with those forecasts. But in a risky venue like foreign-exchange trading, sometimes it's better to take your fake profits before they evaporate again.
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