Trading Tips

Investing vs. Trading in Forex

With the advent of the Currensee Trade Leaders program, the idea of investing in the currency market has been brought to the fore in a way it never was previously. We can now really think of “investing” in forex, not just trading.

Trading vs. Investing
Actually, the term “investing” has been used in terms of forex before. It’s been used in the same way one talks about investing in individual stocks – as a loose term that also accounts for what we would call trading. I’ve written on the subject of differentiating the two approaches (Trading vs. Investing, The Difference Between Trading and Investing), so I won’t get into a lengthy discussion here. I’ll just suggest that investors tend to be much more prone to using fundamentals and much less inclined to use leverage. This article on a personal finance site uses the term “investing” but clearly is talking about what I (and I’m guessing you) would call “trading”.

Forex trading, alas, continues have a very negative connotation among investors. A couple of comments on the aforementioned article talk about how quickly you can lose money. One commentator says “This is akin to day trading on margin & is the easiest way to ruin your financial life”. Of course this assumes all forex traders are day traders and one need only look to the Currensee community to realize that’s not the case at all. But I don’t think any of the Currensee members would call themselves a currency investor.

Forex Investing
But that’s not to say forex investing hasn’t been available. We’ve had currency ETFs and the like for some time now. They allow for both trading and investing in the forex market. Traders can obviously use them to play shorter-term term moves, though my guess is most lean toward the spot or futures market where more leverage is available. After all, day-to-day volatility in exchange rates is on the low end of the relative volatility scale among the markets.

The currency ETFs, though, allow investors to play the bigger macro themes in the market. Think the euro is going to blow apart? You can play the euro ETF. Think the Fed’s printing of money via quantitative easing is going to massively devalue the greenback? There are dollar ETFs you can play to take that position. Just in the last year we’ve seen a couple of 10%-20% swings in the USD Index that investors could certainly have played based on macro themes.

Investing in Someone Trading Forex
The Trade Leaders program adds another dimension to the possibilities of forex investing. I’ve already commented on some of its benefits (see The Benefits of Investing in Successful Traders). Above all that, though, is the opportunity the program provides you as an investor can put someone (or several someones) with a demonstrated track record to work managing your money, like mutual fund investing or other money management programs. Are there functional differences? Sure. The main concept is the same, though, in that you can have your money working in a way you likely wouldn’t be able to do yourself.

Trading Tips

Borrowing to Fund Your Trading or Investing

I’ve recently been thinking about some things related to my own personal finances in regards to taxes, investing, and debt pay-down. Over the next couple months I have quite a few important decision to make. All of this thought got me to thinking about the idea of borrowing to trade or invest. It’s a subject that comes up from time to time among market participants.

Borrowing for Trading
For the record, I’m not generally a proponent of borrowing to fund one’s trading. This is especially true if you don’t have sufficient non-trading income or resources to pay the loan back if the trading doesn’t produce the anticipate performance. The risk of disaster is too great.

You do not want to be in a position where you take some trading losses and cannot make the requisite loan payments. That’s a quick way to destroy your credit and/or personal relationships. It’s really easy to get caught up in positive thinking and be sure you’ll do well enough with your trading to repay the loan. We don’t need to look too far to see what that sort of mindset did to people in the housing market.

Borrowing to Invest in Your Retirement
Now, having said that, there can be instances where borrowing (or not paying down debt, which is effectively the same thing) to fund investing or trading makes sense. That’s when you can lock in a spread. The easiest example of this would be borrowing at 5% and being able to put that into a 7% bond, or something of that sort. There are other situations where things are a bit more complex.

Consider an IRA (or another equivalent tax-deferred retirement investment account). Depending on your marginal tax rate and the rate you’d pay on the debt in question, it could make a lot of sense to borrow to fund a contribution to that account. Let me walk through an example to demonstrate.

The maximum current annual tax deferred contribution to an IRA account for an individual is $5000. Let’s say that we can borrow at 10% and that our marginal tax rate is 28%. The length of the loan impacts how much of a benefit we see in doing so. With that in mind I’ll present two different scenarios. The first is a 1-year loan. The second is a 5-year loan.

1-year Loan
Tax Benefit: $1400 (28% marginal tax rate x $5000)
Loan Interest: $275 ($439.58 monthly payment x 12 – $5000 initial amount)
Net Benefit: $1125

5-year Loan
Tax Benefit on the IRA investment: $1400 (28% marginal tax rate x $5000)
Loan Interest : $1374 ($106.24 monthly payment x 12 – $5000 initial amount)
Net Benefit: $26

That’s just a first cut look at things. If that $1400 tax benefit is actually a tax refund, it could be used to paydown 28% of the loan, reducing the total interest cost of the loan, especially for the longer-term one.

I’m not even including the actual return on the IRA investment in the equations here. At a 5% rate of return (compounded), that $5000 grows to over $8000 in 10 years and over $13,000 in 20 years.

This does, of course, assume that you can make the requisite payments from your normal pay since you certainly won’t be pulling money out of your IRA to do so – unless you want to get hit with a penalty and tax bill. Run the numbers, though. See if it makes sense in your circumstance.