- Many small time investors have been burnt in FX trading recently as the Yen changed direction - Despite gigantic marketing efforts from trading platforms, FX trading is not a guaranteed win-win - Investment U's Alexander Green offers some wise advise

By Alexander Green , Investment U’s Chief Investment Strategist Monday, March 21, 2011: Issue #1473

Pity the average investor…

He got burned a decade ago day-trading Internet stocks. His “sure-thing” real estate speculation turned out to be a bad thing. And The Wall Street Journal reported last week that thousands are now getting hammered in the “carry trade.” What’s left to take a beating on? (Oh yes, call options and futures on precious metals. But we’ll leave that for another day.)

I cringe a bit whenever I hear the term “mom-and-pop currency traders.” What does the typical investor know about trading world currencies? As someone who spent 16 years working with retail investors, I can assure you that it’s very little. And if they truly understood the long-term odds of success, they’d gather their rapidly shrinking pile of chips and head off to Las Vegas, where at least you get free drinks served by beautiful women while you lose money. But I digress…

Carry-Trade Investors Impacted by Japan’s Disasters

The carry trade isn’t hard to understand: You borrow money in an ultra-low yielding currency like the Japanese yen. Then you invest the proceeds in a higher-yielding currency. For example, places like Brazil , Mexico, or South Africa. You earn the interest-rate difference and can make a lot of money – especially when you get leveraged up. Until, that is, you don’t.

The fly in the ointment appears when your high-yielding currency tanks or, conversely, your low-yielding currency rallies. That’s when the strategy comes undone. And the losses from it can be quick and severe. That’s what carry trade investors the world over have learned recently, as the yen soared, following the devastation that has wracked Japan.

Why would the yen rally after a national disaster ? Because the Japanese are busy bringing their money home. And mom-and-pop currency traders in Japan – who make up an astonishing 30% of daily volume according to the Bank for International Settlements – are adding fuel to the fire by bailing out of their losing positions. The whole thing “is now unraveling,” says Brian Dolan, Chief Currency Strategist at Forex.com. And we may still be in the early stages.

Follow These Five Rules First When Branching Out in the Currency World

Mark Konyn, Chief Executive of Money Managers RCM Asia Pacific, says many people have invested in highly leveraged currency funds, designed to juice the yields on already high-yielding currencies. “If those get unwound, it could be colossal,” he says. What’s the lesson here? Certainly not that traders should have seen the disaster coming in Japan. That wasn’t possible. The surge in the yen came out of left field, too. But here’s something every budding currency trader should know. Industry figures reveal that 96% of forex traders lose money and end up quitting.

There’s a lot of money to be made by selling currency trading systems and advice to novice investors. But there’s much less money to be made trading currencies over the long haul. The lessons here? Educate yourself before you invest in something new. Make sure you understand the risks, as well as the potential upside. Don’t invest (or trade) outside your area of competence. Start small (or not at all). Don’t expect well-paid industry “experts” to provide objective analysis.

Follow these simple rules and you can avoid learning about forex risk “the hard way.”

Good investing, Alexander Green

Reprinted with permission of the publisher. The above story can be read on the website www.investmentU.com. The direct link is: http://www.investmentu.com/2011/March/carry-trade-investors.html

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