Investing in Currencies Vs. Stocks

Some people like to “invest” in currencies. Those traders or investors may be coming from other markets and want to apply their investment skills to the currency markets. They are used to holding a basket of stocks and holding them for months or years.

And that may work fine in stocks some of the time. There can be certain companies or many companies that experience trends and momentum for months or years. That certainly happens.

Currency Markets Are Different

But currency markets are different. With stocks there are hundreds and thousands of stocks to choose from. With currencies there are not hundreds or thousands of currencies for you to potentially choose from.

Well there are 196 countries in the world. But if you get rid of some of the rogue states, and nations isolated from the international community, and countries with massive corruption and no rule of law, with hyperinflation then that quickly dwindles down the number. You aren’t going to find people investing in currencies from Afganistan, Iraq, North Korea, Sierra Leone, etc. Even if there is actual foreign investment in those countries, the currency will not be liquid enough for you to trade or invest in. It just is not going to happen.

Therefore, removing those currencies doesn’t leave you with many potential currencies to invest in. Which is why you cannot treat investing in currencies the same way that you treat investing in stocks. With stocks you have a much larger pool of companies from which to choose from to find those nice long term trends. With currencies that pool is drastically smaller. Which means that the chances of a long term trend developing and you capturing the move is much smaller.

Which means that you need to think about it much differently.

Global Macro Trends do occur, just not as often. You cannot be expecting to catch them everyday.

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Investor Mindset

The investor mindset from someone who has played in the stock market can destroy them in the forex market. The investor will approach the forex market with the believe that they can find “value” in currencies or they will be able to buy growth currencies. They sometimes believe they can do a heck of a lot of research to dig deep into a countries economic data and balance sheet. They believe they can find value and invest in currencies for the long term.

That is one of the big reasons why Warren Buffett lost over $1 Billion in the forex market.

And there are definitely certain macro trades where you buy currencies in which their economies will tend to experience growth and thus potential for higher interest rates. These are usually types of trades that the wealthier traders, investors, institutional players and hedge funds have access to. The big players can trade currencies that less liquid than the EUR/USD and have high spreads. The big players have the option to trade currencies from countries such as Brazil, Mexico, Hungary, India, Sweden, Singapore, South Africa, South Korea, Poland, Norway, Denmark, Thailand, etc. The big players have the option to trade those because they can access the liquidity with prime broker relationships and the platforms they offer. They also use less leverage and can absorb the higher spread costs.

The retail forex trader typically likes to trade with some leverage. Sometimes substantial leverage. And you cannot trade illiquid currencies, or currencies that have high spreads with substantial leverage. Thus the retail forex trader tends to avoid those currencies. Since they avoid them, they are only generally left with the eight currencies to trade – USD, EUR, GBP, CHF, JPY, AUD, NZD, CAD. And since they are left with only those 8 currencies they are limited in what sort of global macro moves they can capture. They still definitively occur, you just cannot expect to place 100 of them per year.

Government Can Sometimes Intervene

Also forex has a built in affect that attempts to dampen long term currency trends. It is an economic one as well. The stronger a currency, the bigger the trend has been going on, the more the countries exports are hurt. That helps to restrain or weaken economic growth. There are plenty of exporters in Australia, New Zealand and Canada that are feeling some pain. That tends to reduce economic growth or dampen in. It is sort of like an interest rate hike or series of interest rate hikes, only the appreciating currency is doing the work for the central bank. The central bank may not need to hike interest rates as aggressively, or can delay a hike, or skip a hike if the currency is going stronger, because a stronger currency can act as a tool to help restrain demand in the economy.

Also if trends do start to get irrational, central bank policy makers can start attempting verbal intervention to attempt to reverse or stall out the trend. If that doesn’t work they can attempt actual intervention. If that doesn’t work they can start slashing interest rates. If that doesn’t work they can attempt to lower interest rates to negative levels, which has been done in the past before. If that doesn’t work, some emerging market economies can resort to some sort of capital controls, special taxes, etc in order to stop a currencies trend.

That doesn’t mean that intervention will always be successful. The Swiss National Bank and Bank of Japan have failed over the past two years to stem their currencies rise and have only served up better levels for traders to sell USD/JPY and USD/CHF.

With currencies it can be advantageous to use short term trader skills in order to find a nice exit and take profit point.

That contrasts with the stock market where there isn’t going to be a government changing interest rates and politics solely to target a specific company. The company can grow and keep on growing as long as it wants and as long as it can satisfy the needs of the marketplace.

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