Forex Investment and Currency Trading

Hedgers and speculators in the forex market begin with a common challenge: to determine how to best benefit from the foreign exchange marketplace. The speculator must focus on opportunities to generate profits, while the hedger often concentrates on avoiding the evaporation of profits due to exchange rate fluctuation. In either circumstance, the forex trader is best served when operations in forex are treated as any other business challenge. The most common approaches to developing a business plan can be summarized with the following steps:

Determine an objective

This step may seem to fit the practices of the hedger better than the procedures of a speculator, but both entities benefit if they begin with a thorough understanding of what they intend to accomplish in the forex market.

Without a clearly thought-out objective, the speculator may believe that he or she is being overly swayed by the emotionalism of day-to-day exchange rate fluctuation.

Research AND Resource

Accumulate historical information and facts both internal and external. External information may include historical exchange rate fluctuation (charts and tables), interest rate patterns, historical economic information, political considerations, and other factors that relate to the analysis of the forex market itself.

Internal information includes an assessment of the forex trader’s makeup. For the hedger, this means an assessment of foreign exchange risk exposure, an evaluation of the impact of foreign exchange fluctuation on the hedger’s ability to compete, accounting considerations, and other business factors. Since the hedger is likely to be a multinational firm, tax considerations must be evaluated along with the potential for regulatory and/or bylaw restrictions. For the foreign exchange hedger. exposure can be divided into two categories: accounting or translation exposure and economic exposure.

For the speculator, research may not be nearly as complex as that of the hedger, but it is no less important. In addition to gathering statistical and economic information (external information), the speculator must come to terms with the amount of risk capital he or she is willing to devote to the enterprise (internal information). Determination of risk capital will help the speculator avoid the exaggerated effect of emotions on trading decisions. Risk capital is best defined as the amount of money the speculator could lose without impacting lifestyle, standard of living, retirement, and emotional well-being. Risk capital is a wholly subjective consideration but is seldom greater than 15% of total net worth,

Develop a plan
This is the “what, how, and who” step. What is the forex trader going to do? How is the trader going to do it? With whom is the trader going to implement the plan? The more specific the plan is, the better. Specific, but not inflexible: The exchange-rate landscape can change rapidly, sometimes redefining even basic principles. An inflexible plan can be a formula for disaster. “What-if’ scenarios are important. The speculator must ask, “What should I do if my analysis is correct, and what should I do if my analysis is wrong?”

Implement and execute the plan

For beginning hedgers and speculators, the key here is to start small. Even the best-designed plan will show flaws and a need for minor refinements when applied to the “real world.” Starting with a smaller position will also reduce emotionalism and enable the forex trader to make a more detached evaluation.

Monitor the plan
The forex trader should monitor the plan to determine if it is being followed, and if it is meeting objectives, reaching benchmarks, or achieving other desired results. For the speculator, this is a good time to evaluate the emotional and financial impact of the investment on his or her well-being.

Evaluate the results

It will be important for the hedger to objectively evaluate the transaction on the firm from both an exchange risk and an accounting perspective. An independent assessment by an outside accounting or consulting firm may be appropriate to assure objectivity. The speculator must determine if the results justify the headache.

Whether a person is a hedger or a speculator, the creation and implementation of the plan are likely to involve forecasting the future price movement of currency exchange rates. The two most common forecasting methods are fundamental analysis and technical analysis.