Is it Time to Invest in Forex – No

There are two fundamentally different ways by which investors determine where to invest their money: – trend analysis, and fundamental analysis. It does not matter in what entity you invest – the stock market for equities, the bond market, the derivative market, even the forex market – you need to understand your reasons for choosing an investment if you wish to be successful.

Trend analysis involves determining the price trend of one commodity over time. Analysis of that trend determines when to buy and sell that investment. Analysts would look at the price of that commodity, the smoothed average, the volatility and the number of buyers and sellers in the market. Depending on the timeframe of the investment they would look at different smoothed averages – typically 5 and 21 day averages for short term trading, 90 day, 120 day and even 180 day averages to determine longer term trends. They all have their own formulae to determine how the averages must change related to the volatility to determine whether to buy or sell. The actual ‘intrinsic value’ of the commodity is not of importance.

Fundamental analysis, on the other hand, involves researching the ‘intrinsic value’ of the commodity and buying if the price is cheap compared to the value, selling if it is too expensive. For an equity for example, the company would be analyzed, the future expected profit and cash flows analyzed, the book value investigated  and a ‘fair value’ based on these fundamental calculations would be calculated for the company. This fair value would be divided by the number of shares to provide a ‘fair value’ price per share.

The same two methods hold true for the forex market.  Using your home currency you buy or sell foreign currency, naturally depending on any currency regulations in your home country. If you are a pure investor (or speculator) you generally do not need to take possession of the currency bought – it is held on account for you by your currency broker.

Once again you determine what currencies to but depending on your chosen investment decision method – fundamental analysis or trend analysis.

It is here that the small investor is at a serious disadvantage. A fundamental analysis of the various currencies would require a good knowledge of the economic environment in the countries owning those currencies, and how the changes in that economy differ from your home country. While a good researcher can find out a lot of information on the web, we do not have the personal feel for a foreign country that we have for our own. What we learn is initially academic and not daily gut feel. Our research therefore has to be that much more thorough. Furthermore countries are notoriously loathe to release bad news – it is bad for the economy when investors can freely withdraw their money and invest it elsewhere (and politically bad for the government). The recent situation in Greece is an example.

For the small investor, therefore it would appear as if trend analysis is more acceptable for forex investments. However as trend analysis ignores events, any volatility would have to be ridden out, potentially straining the small investors account.

With the current economic climate in turmoil worldwide, the forex market shows high volatility.  As an example if we compare the dollar with the Euro over the last six months we see the exchange rate has gone from $1.36 in April to $1.34 now (end September 2010), with a low in June of 1.19. The six month trend is therefore flat, while the short term (3 month) trend is dollar weakness. This may imply a long term weakening of the dollar, but this has not yet been confirmed.

This evidence suggests that it is not a good time for the small investor to invest in forex.

[It is advised that you consult your tax advisor or investment advisor before you invest to fully understand the tax implications.]