This Is One Speculative Investment You Should Avoid

Credit: Neil

Currency speculation, or more popularly known as forex trading in Singapore, seems to be a popular thing.

Anecdotally – from the forums I frequent, to the people I talk to – there seems to be a strong allure to this whole act of guessing how different pairs of currencies would move in relation to each other.

It’s no real surprise given that forex trading often entails the use of high leverage – and that means the potential for large and quick profits with little money down.

But, there is a good reason for retail investors (people like you and me) to consider staying away from that casino circus and that is, the odds of losing are high. Very high.

Sky-high odds of losing your shirt

Back in October, I chanced upon a Financial Times article which described the experience of forex traders in France. I was stunned by the figures I saw. This is what I wrote about it:

“Try this statistic from a French financial regulator Autorité des Marchés Financiers: “In four years, the percent of clients losing money for all providers combined is nearly 89% [emphasis mine].”

…The piece detailed more from the French regulator, who showed that the “average loss per client was nearly €10,900 between 2009 and 2012” and that over four years, “13,224 clients together lost nearly €175 million, while the remaining 1,575 clients earned a total of €13.8 million.””

The Financial Times article also added that “most active and regular investors see their losses mount over time.”

And just last Friday, The Wall Street Journal published an article, showing that the experience of losing money by speculating on currencies is not something unique to the French – the Americans suffer in spades too.

The article, which had a pretty self-explanatory title of “Six in Ten Mom-and-Pop Currency Traders Lose Money Each Quarter,” said that “a weighted average of [only] 38.3%” of U.S. retail traders in six of the largest retail foreign-exchange brokerages had made a profit in the third quarter of 2014.

The inherent difficulties

Although circumstances may differ between each retail foreign-exchange broker, there are still common underlying themes as to why it’s so difficult for retail investors to make money by speculating on currencies. My colleague Brian Richards explains:

“The vast majority of currency trades are made by hedge funds, large corporations, and central banks. In other words, your counterparty in a currency trade is likely to be someone who is — and this is important — vastly more qualified to make currency trades than you are.”

And even then, to show how difficult it is to play this currency game, even the big hedge funds are also not immune to losses. Just ask Marko Dimitrijevic, who had to close down his US$830 million hedge fund last week after a bet on the decline of the Swiss franc had gone awry.

Never learning from the mistakes of others

Sadly though, even with the published figures such as those from the Financial Times and the Wall Street Journal, it’s likely that the behaviour of many wouldn’t change.

According to the same Wall Street Journal article I referenced earlier (emphasis mine), “[a] survey included in a 2014 Citi presentation about the retail forex market shows that 84% of current and potential traders believe they can achieve positive monthly returns.”

If that’s not overconfidence and an unwillingness to learn from the errors of others, I don’t know what is.

Playing a different game

The real unfortunate thing for the forex traders is that, there’re other avenues for them to make money with far less risks. When I wrote about the Financial Times article, I pointed out that forex trading and stock market investing differed in one very important aspect and it seems apt to repeat this here again:

“The game forex traders play is on an entirely different ball court from that of share market investors – for a simple reason. The odds of success can be stacked in an investor’s favour over time. Over the course of more than 140 years of market history in the U.S. between 1871 and 2012, investors with a holding period of 20 years have never suffered a negative annualised return.

And an investor wouldn’t even need special investing skills to succeed. All that was needed was wide diversification (through a low-cost index fund, for instance), patience, and the fortitude to hold on for the long-term.

I have also done similar studies (the time period is much shorter as market data in Singapore does not go as far back in time as in the U.S.A.) with Singapore’s market using the Straits Times Index (SGX: ^STI) and the conclusion was pretty much the same: Lengthen your holding periods and you’d see the odds of making a profit increase dramatically.

This plays into an interesting but, in my opinion, often-overlooked aspect of investing: Over time, the share market has gone down faster than it moves up, but it moves up more than it has gone down. This puts the odds squarely in the long-term share market investor’s favour.”

The ball’s in your court now. Which game do you want to play?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.