The global foreign exchange (forex) trading market has come far from being just a currency-hedging tool to being a full-fledged asset class now, believe experts.
According to a recent report published by Celent, a global research and consulting firm, while in early 2009, there was a substantial decrease in the forex market with $2.9 trillion (Dh10.64trn) in average daily volume, it is estimated that the market should exceed $4trn in average daily turnover by 2010.
The forex trading volumes have been increasing dramatically in the UAE as well. The trading of euro/dollar, GBP/dollar, Indian rupee/dollar and yen/dollar futures contracts on the Dubai Gold & Commodities Exchange alone has jumped substantially, with the total currency volume touching 104,614 contracts last month, up by 463 per cent year on year. On January 29, the exchange recorded its second-highest daily volume for currencies with 9,892 contracts, valued at $674 million. This was close to the record 10,669 contracts registered in August 2009.
But is the forex trading in the region being driven by currency fundamentals or are overtones of speculation encouraging more and more trading? How can an individual trade in forex as an investment class, what is the significance of forex trading for a common investor (who is not a trader) expecting to make money out of it? What are the risks an investor should be aware of when entering into forex trading? And lastly, has the US dollar's weakness enhanced the importance of forex trading as a risk-mitigating tool against currency fluctuations?
Emirates Business got five major forex players to do the talking on key issues to get the real picture – Betsy Waters, Global Director, dbFX, Deutsche Bank's online forex trading platform, New York; George Tchetvertakov, Head of Market Research, Alpari UK; Mario A Camara, Managing Director and Chief Legal Officer, ACM Middle East DMCC, Dubai; Jakob Thomsen, CEO, Saxo Bank Dubai; and Pradeep Unni, Senior Research Analyst/Trader, Richcomm Global Services, Dubai.
Retail traders in the region continue to look to diversify their portfolios by investing in forex. I believe there are three factors behind this growth in forex trading – transferable skills from other asset classes, advantages of forex as a trading asset class and ever-improving technology.
The fundamental principles of trading forex are similar to those required for other asset classes. Active traders, who are following technical and fundamental analysis of the global markets, are well-equipped to take a view on the direction of the forex markets and, therefore, able to diversify their investment portfolios from traditional bond and equity assets to forex, thus spreading their risks effectively across asset classes.
For sophisticated investors, who are looking to put a proportion of their investments into a diversified asset class, forex is ideal because of its 24-hour liquidity, tight spreads and convenient access to margin and non-correlation to bond and equity markets.
Investors increasingly want to make their own financial and investment decisions and with the development of sophisticated trading platforms, they now have access to the forex markets from their home or office. Advanced trading tools such as trading from charts, and risk management tools such as stop-loss limits assist investors to trade, manage risk and be better informed.
The major market participants range from self-directed traders to forex managers. Active traders of alternative asset classes such as commodities have realised that much of the discipline required to trade forex is similar to the fundamental approach they already successfully employ, and therefore can easily include currency trading in their portfolios.
Investors who believe trading forex is the correct way to diversify their portfolios but feel that self-directed trading is not the correct approach for them, may opt for a managed account. A managed account is an investment account that is owned by an individual investor, for whom the trading decisions are made by a professional forex money manager. This solution offers investors a means to access and leverage the benefits of forex, but without having to actually trade themselves.
Individuals with investments across asset classes may add forex to their portfolio to diversify their revenue streams. The main reason to add forex is to diversify away from correlated one- directional asset classes such as bonds and equity to an asset class that has contrary market drivers. Forex trading can be used to hedge the natural currency exposures of an individual's investment portfolio. But investors should be careful to not confuse the direction of the dollar with the ability to mitigate risk or not. Each individual must first look at their unique investment portfolio and determine what their risk exposure is.
We have seen trading volumes from our Middle East- based clients rise very rapidly over the past two years. This is a result of an increase of new investors entering the forex market. Since the outset of the financial crisis, retail forex volumes have soared to record levels, driven by higher volatility in all forex pairs. The rationale behind this increase is that retail forex traders were lured into trading by attractive returns offered by higher volatility. During the same time, institutional trading volumes fell by as much as 30 per cent globally because it became much more difficult for large investors to cover their forex exposure on a daily basis. In addition, lower levels of international trade, M&A and foreign investment suppressed forex trading volumes.
With many forex brokers opening their regional offices in the Middle East, and new local companies being established on a regular basis, competition has increased significantly. Forex is appropriate for both retail and institutional investors despite their varying investment needs and goals. The forex market is primarily traded online via a user- friendly trading platform that includes charting, multiple analysis tools and real-time news, freely available to all users.
Forex is a very good asset class for trading purposes given its high liquidity, extensive trading hours and low trading costs. When it comes to investment returns, forex can be an excellent asset class to invest in provided the investor understands all the risks. An individual looking to achieve investment returns should be extremely cautious of the leverage he is using when trading and must also implement strong risk management measures to safeguard the original investment. If traded responsibly, currencies can be a good investment opportunity but if excessive leverage is combined with unrealistic profit targets, the individuals' capital can become depleted very quickly.
The US dollar's weakness has been both a sign of investor confidence as well as a cause of cyclical currency strength as sidelined US dollar-denominated assets were reinvested into higher yielding, more profitable investments around the globe. We think that US dollar price action over the past six to 12 months is not related to how important forex trading is as a risk mitigating tool. However, large institutional investors have seen a diminishing need to cover currency exposure over the past 12 months because forex volatility has been declining very sharply alongside a fall in the dollar.
Our trading desk in Geneva reports that forex trading volumes in the UAE are robust and the growth forecast for future volumes remains solid. The growth story of forex trading in the Middle East and specifically in the UAE has been nothing short of a tremendous success story.
The forex market is largely made up of institutional investors and retail participants. Institutions can use these markets to strategically add value to their existing core businesses. For example, companies dealing with partners outside the UAE generally tend to conduct business in currencies such as euro, Indian rupee, Swiss franc or Japanese yen. To cover their physical exposure to fluctuations in currency prices, they can use currency-trading specialists to hedge such exposure.
Due to the very volatile nature of the currency markets, institutional investors can use such strategies to minimise their exposure to risk and maximise their gains. A large part of the marketplace also consists of individual market participants – retail investors. We have seen a large surge in retail participation in the past few years, simply because of the ease and liquidity of investing in the forex markets. There are several brokers out there offering trading services. However, picking the right one requires a lot of due diligence. When picking a broker, it is important to look at factors such as range of products, regulatory bodies and, of course, the financial strength of your broker.
Forex trading can provide individuals with an excellent opportunity to diversify their existing investment portfolios to generate an additional or alternative revenue stream. Most of our clients are investors in equity markets as well as real estate markets, and what we have seen is that by investing in forex markets they are able to take advantage of the volatile nature of markets. Therefore, even though equity markets are not as volatile as forex markets, and since the real estate market has stagnated, of late, by investing in the forex market, investors can capitalise on opportunities even in market downtrends.
Although currency value fluctuation tends not to affect smaller, individual retail participants, large institutions dealing in dollar-denominated contracts can derive great value by hedging their physical exposure through currency markets. Companies entering into international transactions often fix their contracts in currencies different from the ones they use to purchase raw materials and pay suppliers. By offsetting the physical price of the foreign currency through which a particular commercial contract is executed, such companies can minimise their exposure to currency fluctuations. Naturally, the larger the contract size the larger the gain for such institutions.
What we find interesting is the significant increase in clients trading foreign exchange as an asset class in the region. Forex trading has in recent years become increasingly accessible to the individual investor, who is also more educated and informed than ever before. In a globalised world, people are increasingly exposed to fluctuations in foreign exchange rates, especially in a place such as the UAE, which has a high number of expatriates.
Forex as an asset class holds a number of advantages towards other asset classes, but also significant level of risks that the investor should be aware of. It is a volatile and fast market, and a strict discipline is needed if investors are to succeed. Take good time to practice demo accounts and learn the fundamentals and technicals of the market. The forex market is the world's largest and dwarfs both the global equity and fixed-income markets. Compared to other asset classes, the investor has the possibility to leverage his positions, and he is not confined to a certain direction in the market as he can choose to buy or sell the same currency crosses. Forex is a zero sum game – when you beat the market you truly beat the market.
There are a number of brokers and banks in the UAE offering forex to individual investors, and not all of them offer the same level of transparency and security. When deciding on a broker, make sure to investigate the history, regulatory framework the company works under and the size of the company in question. An investor can trade the foreign exchange market in various ways such as spot, options, forward outright or through exchange-traded futures.
Dollar's weakness has definitely enhanced the importance of forex trading as a risk-mitigating tool against currency fluctuations. While the majority of our clients trade in order to achieve speculative gains, we also have a significant number of clients seeking to hedge their exposure to the dollar.
The prominence of the UAE and the region in the global trade arena is increasingly making currency trading and hedging more of a necessity than a choice. The presence of a highly-liquid commodity and forex exchange (DGCX) with settlement guarantee and counter-party risk managed by Dubai Commodities Clearing Corporation is providing an ideal platform to trade forex currency pairs. Such highly liquid contracts have also attracted a lot of speculators and arbitragers who take the benefit of the short-term direction and the inter-exchange currency spreads.
Major players in the markets are speculators, arbitragers and hedgers. Any individual trader or investor can benefit from currency moves by opening a trading account with registered brokers on the DGCX. The investment required is quite minimal and the contracts are highly leveraged. Investors can take the advantage of standardised contracts and far-month currency products.
Forex trading offers a route to financial freedom, which is not available in other investment avenues. Trading various currency products offers more flexibility and also provides an opportunity to profit from the global macroeconomic, geopolitical and fundamental developments in different nations. However, it is pivotal to remember that currency trading or investment is highly risky and proper knowledge or expert advice needs to be garnered before an investor ventures into this investment option. Macroeconomic developments, geo-political risks and financial stability of individual nations are directly reflected into the currency prices.
Forex trading has certainly emerged as a risk-mitigating tool and the high volatility in currency pairs is forcing many export-import firms to opt for hedging in order to protect their balance sheets from sharp moves in currency.
Though US dollar rates are fixed in the UAE and other GCC states, firms are still exposed to risk in currency pairs when they trade with other nations. With India being such an important trade partner, Indian rupee currency risk management – the only one of its kind outside India – is also provided on the exchange here.
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