Revealing the myths behind forex investments

These days, we see lots of ads for books, seminars and software that purport to show you how you can consistently make returns of 50% to 100% (or more) yearly in forex investments. Some even go so far as to say you can do it in a few minutes a day.

Forex investments involve dealing in foreign currency futures and options. Futures and options on foreign-exchange investments (or anything else) offer a great deal of leverage. If you could get that leverage to consistently work for you, you could make the kinds of returns on your initial stake that promoters of forex investments claim.

However, leverage works two ways: It magnifies your profits when the market moves in your favour, but it magnifies your losses just as effectively when the market moves against you. That’s because the amount you owe on your investment loan stays the same, so every dollar you lose comes out of your equity.

How investors lose in forex investments

Dealing in foreign currency futures or options can make sense for a business that is forced to take on unacceptable currency risk. Futures or options let the business pass that risk on to speculators who wish to accept it.

However, most speculators who succumb to the lure of foreign-exchange wind up losing money. It doesn’t matter if investors trade foreign currency or a traditional commodity, such as wheat. In the end, they almost always wind up losing.

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Here’s how things typically work out: Suppose an investor starts out with the intention of losing no more than, say, $15,000 on currency futures trading. After a few months, the investor will typically have broken even on his futures trading — if you ignore commissions. But if you count commissions, which obviously have to be paid, the investor will have lost about $15,000.

In other words, the futures trades on foreign-exchange investments work out like bets on a series of random events, such as coin tosses. You’ll win a few and you’ll lose a few, but you won’t win enough to pay your commissions, let alone leave yourself with a profit.

If you were to invest the same amount in a portfolio of stocks, you would spend only a few hundred dollars on commissions. This disparity gives futures and options brokers a huge incentive to recruit clients and try to pump up their enthusiasm and confidence.

Aggressive U.S. stocks provide a lower-cost way to speculate on the U.S. dollar than forex investments

If you want to speculate on currency movements — specifically those of the U.S. dollar against the Canadian dollar — we think you would be far better off buying aggressive U.S. stocks than forex investments. You could select companies from our Wall Street Stock Forecaster newsletter’s Portfolio for Aggressive Growth.

The U.S. dollar dropped sharply in 2009 due to fears that President Obama’s spending plans would drown the U.S. economy in debt. However, Obama needs the support of his party and the public to implement his plans, and both seem to be decreasingly enthused about them. As resistance to higher U.S. federal spending becomes more widespread and more widely recognized, we think there is a strong possibility that the U.S. dollar will rise.

Of course, no one can consistently predict foreign-exchange rates. Any rise in the U.S. dollar may need weeks or months to get going. But if you are thinking of adding more U.S. stocks to your portfolio, now is a great time to get started.

You always get our latest analysis of the best U.S. stocks for Canadian investors, including clear buy/sell/hold advice, in Wall Street Stock Forecaster. Click here to learn how you can get a one month free trial.