Trade in forex ? Manage your risk

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How to invest in currencies

* Trade currency pairs online: For example, one could buy a euro/US dollar pair, If one is expecting the euro to appreciate against the US dollar. There are several brokerages which offer forex trading, including Saxo, IG Markets, GFT Asia and Phillip Futures.

* Currency-linked investments: Also known as dual currency investments, these are short-term structured products that allow the investor to make a punt on the direction of a currency paired against another currency. Such products are offered by all three local banks.

* Foreign currency deposits: These deposits usually earn much higher interest compared with Singapore dollar deposits.

* Emerging market bond funds: These funds primarily invest in high-grade corporate bonds or foreign government bonds in emerging markets such as Indonesia, Brazil and China.

Trade in forex ? Manage your risk

Investors can turn to numerous products to get less-risky exposure to highly volatile currency market

For most people, dabbling in foreign exchange or forex, in short, is perceived to be largely a speculative activity, reserved for people who are either sophisticated traders or speculators.

This is true to a certain extent. Trading directly in the forex market, where spikes in exchange rates are common on a daily basis, often carries much risk.

But there are ways to manage the risk and numerous products to allow investors to get exposure to the forex market without getting hit by excessive risks.

Trading currencies

The most direct way to get forex exposure is simply to trade currencies. This can be easily done online.

Several companies such as Saxo Banks, IG Markets, Phillips Capital and even banks give retail investors direct access to the forex market.

Forex trading is commonly done as a currency pairing - for instance, the euro against the US dollar. Traders can either buy or sell a currency pair. For instance, if a trader buys a euro/US dollar pair, he is expecting the euro to appreciate against the US dollar.

The advantages of trading directly in currencies are numerous: The forex market is the world 's most liquid market, with a daily turnover of more than US$3 trillion (S$3.7 trillion).

At the same times, the forex market is open 24 hours a day except on weekends. This means a keen trader can take positions around the clock.

Moreover, forex trading allows you to take large leveraged positions, of as much as 200 times. This means that you can use $100 to trade up to $20000 worth of currencies.

But IG Markets head of media and research Justin Harper notes that despite these advantages, it would be unrealistic for people to expect big profits from trading currencies. This is because while you can win big, you can lose big too.

"There are many risks that are inherent with trading forex as it is such a fast-moving, incredibly liquid and volatile assets," says Mr Harper. "Markets can move very fast against you, so you should always set up some kind of stop-loss, either electronically or by having a figure in mind to get out at."

There are ways to reduce the risk such as limiting the amount of losses made per trade and being very disciplined about trading, says Mr Harper.

But investors should be aware of the risks before jumping in.

Currency-linked products

Another way to get currency exposure is through a relatively new product called currency-linked investments, or dual currency investments, offered by all three local banks.

These are short-term structured products that allow the investor to make a punt on the direction of a currency paired against another currency.

Here is how it works: A consumer chooses a currency pairing based on a predetermined "strike price" and a fixed tenor.

As an inducement, the bank will offer a fairly high interest payment for the duration of the contract.

If the price of the pair rises above the strike price level at the time the contract matures, the consumer cashes out his investment in the base currency. This means that he gets his original investment amount back plus interest.

Should the price of the pair fall below the strike price level, the consumer get his returns back in the alternate currency plus interest. This scenario will likely result in a loss for him.

OCBC Bank head of premier wealth advisory Michael Tan says: "This is ideal for clients if they are willing to take a risk on exchange rates between two currencies and receive their principal plus interest in either of the two currencies."

There are also insurance products that one can invest in that are linked directly to foreign currencies , says Ms Mah Ching Cheng, DBS Bank head of investment communications.

The bank recently launched a single premium insurance plan that is denominated in yuan.

"This single premium plan offers a potential annualised yield of 2.85 per cent per annum and protection coverage on death," Ms Mah says.

Those who prefer uncomplicated products can put their money in foreign currency deposits with the banks. These deposits usually earn much higher interest compared with Singapore dollar deposits.

And given the lost rates and high inflation here, Ms Mah notes that investors prefer currency investments that would potentially get better returns than Singapore dollar deposits.

Overseas funds

Another way to get currency exposure and high yields is to invest in emerging market bond funds.

These funds primarily invest in high-grade corporate bonds or foreign government bonds in emerging markets such as Indonesia, Brazil and China.

They pay out potentially high yields, as investors demands greater compensation to offset the higher risk of investing in sovereign debts of emerging markets.

For instance, Indonesia's 10 year bonds are currently yielding around 5 per cent.

Mr Brian Tan, head of retail sales at JP Morgan Asset Management, says that investing in emerging markets' local currency debt is one way to gain exposure to both foreign currencies as well as high yields.

"Local currency debt also currently presents the opportunity for investors to benefit from significant undervaluation in some emerging market currencies."

JP Morgan has an Emerging Market Local Currency Debt Fund which allows investors to gain exposure to local currency-denominated emerging market debt.

At the same time, Mr Tan says there is the potential to benefit from strong growth in emerging market bonds over the long term

Diversifying the risk

Regardless of which options one takes, the key to successful investments in foreign currency is managing risk.

On this front, Ms Mah says diversification is key.

"The proportion of currency exposure you should have in your portfolio depends on your risk appetite towards foreign currency," she says. "But, if you want to grow your wealth using currencies, it helps to adopt the mantra of experienced portfolio managers by investing in a diversified portfolio."

Likewise, currency trading should also form part of an overall portfolio of investments that should include bonds, equities and even real estate, says Mr Harper. "Foreign exchange is a useful asset to hold, for a short-or long -term basis, as long as it sits within a balanced portfolio," he notes.

"Never have all your eggs in one basket and use all your liquid assets to trade forex. You should ideally have money spread across property, equities, commodities and in cash."

Invest, The Sunday Times April 15, 2012 Pg 34