CHAPTER 1 – Profiting with Forex
There is a Forex solution to every question you’ve ever asked about your financial future. We talk with people every day who want to know how they can take advantage of both the good times and the bad times in the economy.
They want to know how to profit from the stock market when it is going up and how they can protect themselves when it is going down. They want to know how they can take advantage of the unprecedented economic growth in China, India, and other emerging markets.
They want to know how to combat inflation to ensure that their retirement nest egg will continue to provide an enjoyable lifestyle. They want to know if there is any- thing they can do to offset rising oil prices. They want to know how to improve their budget when commodity prices—from the price of the orange juice they buy at the store to the price of the lumber for their new home—start to rise. Mostly, they want to make profits. And every time they ask us, we respond with one word: Forex.
Certainly, you could devote your life to learning to understand stocks, mutual funds, and options to take advantage of the ups and downs of the stock market. And you could learn about foreign bonds and exchange-traded funds to take advantage of the growth of the emerging markets around the world. Plus, you could master interest rate futures and government bonds to combat inflation. And to top it all off, you could dive into the commodities market to speculate on the wild swings in the price of crude oil and offset some risk in pork belly and soybean futures. But, really, who has time for all that?
If you’re like most of us, you’ve got a 401(k), an IRA, or another type of retirement vehicle into which you are putting the major- ity of your savings. And that’s a good thing. The stock market has done extremely well over the long term and deserves a place in your overall portfolio. But wouldn’t it be nice if there were a way you could address all the other issues just mentioned without having to become a financial genius? Well, there is.
The Forex market enables you to have the best of both worlds. When stock prices go up, you can profit with the Forex market. When stock prices go down, you can profit with the Forex market. When emerging markets gain strength and begin to grow at exponential rates, you can profit with the Forex market. It doesn’t matter if inflation levels are going up or if inflation levels are going down; you can profit with the Forex market. And as oil and other commodity prices fluctuate up and down and up and down, you can profit with the Forex market. You will be amazed at how easy it is to get involved and make money in this incredible market.
Finally, there is a way for all investors—no matter how big or small—to harness the world around them and secure their financial future. The Forex market is available to everyone, yet so few people know about this universal tool. As you read this book and learn more and more about the Forex market, we guarantee that you will ask yourself the same question over and over again, “Why in the world have I not been taking advantage of the Forex market until now?” Maybe you’ve never heard of the Forex market. Maybe you’ve heard of it but never really knew anything about it. Whatever the reason, today is your day to get started. Once you do, you’ll never look back.
This book will introduce you to all the advantages of the Forex market and show you how to profit from it. It addresses the questions you have concerning your financial future. And, most importantly, it will show you how you can implement the things you learn in your own investing. The Forex market has changed our lives. It has changed the way we view the financial marketplace. We used to see obstacles and limitations. Now all we see are opportunities and freedom. The Forex market is the perfect supplement to our stock and bond investing. It enables us to profit from whatever is happening in the world around us. The Forex market is the solution.
WHAT IS THE FOREX MARKET?
The Forex market is the largest financial market in the world. Nearly $2 trillion worth of foreign currencies trade back and forth across the Forex market every day. Forex stands for the foreign exchange—the financial exchange on which governments, banks, international corporations, hedge funds, and individual investors exchange foreign currencies.
For instance, when you fly to another country, one of the first things you do when you get off the plane is look for a currency exchange counter where you can exchange your U.S. dollars for whatever currency is used in the country you are visiting—such as British pounds, Japanese yen, or euros. Why do you do this? Because you know that the cab driver, the hotel clerk, and the souvenir sales- person are all going to want you to pay them in their national cur- rency, not U.S. dollars.
When you slide your U.S. dollars over to the teller and he or she slides back a stack of multicolored bills—let’s face it, foreign money is a lot more colorful than the greenback—you have just participated in the Forex market. You exchanged one currency for another. Now, if you stop and think about all the people who travel, all the busi- nesses that operate in multiple countries, and all the governments that are exchanging money, you can start to get an idea of how big the Forex market really is.
Those of you who travel abroad frequently have probably also noticed that the exchange rates at the currency counter at the airport never seem to be the same. They are constantly changing. Sometimes you get a lot more bang for your buck when you exchange your money, and sometimes you have to exchange a few more U.S. dollars just to get by. That is because exchange rates are constantly changing, and it is these changes in exchange rates that enable you to make a lot of money in the Forex market.
THE ADVANTAGES OF THE FOREX MARKET
The Forex market enjoys unparalleled advantages. You will find that some markets share similar advantages, but no one market on earth comes close to rivaling the protection, profit potential, and ease of use available in the Forex market. Take a look at the advantages you can find within the Forex market.
The Forex market is the largest financial market in the world. (See Figure 1.1.) Nearly $2 trillion change hands every day. To give you an idea of what an awesome number that is, the New York Stock Exchange experienced record volume during the third quarter of 1998 and cleared only $1.9 trillion in volume—60 times less than the Forex market clears in a quarter. Being the largest financial market in the world is advantageous; it makes buying and selling currencies extremely easy because there are so many buyers and sellers out there. Imagine that you are trying to sell your home, and you had thousands of people standing at your front door—cash in hand— ready to buy the house. It wouldn’t be too tough to sell the house.
The second advantage of the size of the Forex market is that investors are unable to manipulate it. Since potential manipulation is virtually nonexistent, you can be confident that the prices you are getting in the Forex market are fair prices.
Ease of Entry
You do not have to be rich to trade in the Forex market. Everybody deserves to be able to protect his or her financial future, and the Forex market makes this possible by offering an extremely low barrier to entry. In fact, you can open a Forex account with as little as $300.
It doesn’t matter if the value of the U.S. dollar is going up or down. You can make money in the Forex market. If you think its value is going up, you simply buy the U.S. dollar and make money all the way up. If you think its value is going down, you simply sell the U.S. dollar and make money all the way down.
When you invest in most financial markets, you must pay short-term capital gains tax if you take your profits within one year of puchasing a security. If you hold the security for more than one year before taking your profits, you must pay long-term capital gains tax. Currently, short-term capital gains are taxed at your current tax rate, and long-term capital gains are taxed at only 15 percent.
Obviously, it is much better to pay less in taxes. In the Forex market—much to investors’ delight—it doesn’t matter if you take your profits one minute after you enter a trade or one month after you enter a trade. Sixty percent of your profits are taxed at long-term capital gains rates, while only 40 percent of your profits are taxed at short-term capital gains rates. That means you keep more of your profits in your pockets.
For example, imagine you made $10,000 on a six-month trade in the stock market and that you also made $10,000 on a six-month trade in the Forex market. Both trades occurred in taxable accounts, so you owe taxes on both. Assume you are in the 33 percent tax bracket.
Tax Treatment of the Stock Market Since you entered and exited your trade in the stock market within six months, you will have to pay short-term capital gains tax. If you are in the 33 percent tax bracket, you will have to pay 33 percent tax on of the profits. So for a profit of $10,000, you will end up paying $3,300 in taxes.
$10,000 X 33% = $3,300
While you did get to keep $6,700 of the original $10,000 profit, it is never fun to pay taxes.
Tax Advantages of the Forex Market
We all want to keep as much of our profit as we possibly can, and the Forex market allows us to do that. Even though you entered and exited your trade in the Forex market within six months—just as you did for your stock trade—only a portion (40 percent) of your profits is taxed as short- term capital gains.
The remaining 60 percent of your profits get the benefit of being taxed as long-term capital gains. This means that you will have to pay 33 percent on only $4,000 and—according to current long-term capital gains rates—15 percent on $6,000.
Portion Taxed as Short-Term Capital Gains
$10,000 X 40% = $4,000
$4,000 X 33% = $1,320
Portion Taxed as Long-Term Capital Gains
$10,000 X 60% = $6,000
$6,000 X 15% = $900
Total Taxes Paid
$1,320 + $900 = $2,220
You would have to pay only $2,220 with your Forex trade com- pared to the $3,300 you would have to pay with your stock trade. That is a savings of slightly more than 35 percent. Tax savings like that can add up quickly.
You can also accumulate profits quickly by investing in the Forex market within your IRA or other tax-deferred retirement account. Many investors are unaware they can trade anything but stocks and mutual funds within their retirement accounts because their brokers have conditioned them to focus only on these asset categories.
Some brokers don’t want to deal with the extra work that would come from allowing you to invest more freely. It isn’t advantageous for them. On the other hand, other brokers believe that you should be able to choose where you put your money. Check with your brokerage firm and see if it offers self-directed options in its retirement accounts.
The Forex market is open 24 hours a day nearly 51⁄2 days a week. It doesn’t matter if you’re working or retired, a homemaker or a student, you can find a time that works for you to get involved in the Forex market. In fact, the Forex market is usually most active early in the morning and late and night. There are many part-time traders who are able to use these varied hours of market activity to their advantage by trading when they are not at work. The varied trading hours of the Forex market also benefit long-term investors because these investors are able to enter and exit their positions whenever the market dictates.
Every time you buy a stock, a bond, a mutual fund, or a home, you are paying someone somewhere a commission. In the Forex market, however, you never have to pay a commission. The price you see is the price you get. You don’t have to factor in a little extra for the broker. You simply pay the listed price. No more, no less.
The Forex market allows you to control $100,000 with as little as $1,000. This means that you can make your money work harder for you in the Forex market than it can anywhere else. Imagine. You can keep all the profits from a $100,000 trade, and all you have to do is provide 1 percent of the money.
To put this in perspective, imagine that you are a real estate investor, and you see a $300,000 home that you believe is going to increase in value. If you could use the same amount of leverage in the real estate market as you can in the Forex market, you could buy that house with only $3,000 down and a potentially interest- free loan. That would be incredible. Any real estate investor in the country would do anything to get that kind of a deal, and that is exactly the opportunity you have in the Forex market.
Increased leverage is also the point that well-intentioned, but misinformed people point to when they say that investing in the Forex market is risky. Granted, this amount of leverage may seem aggressive, but the Forex market gives you the perfect antidote for the risks associated with increased leverage: guaranteed stops.
You have the ability in the Forex market to determine at exactly which price you would like to enter a trade and at exactly which price you would like to exit a trade—and these prices are guaranteed. A stop, or stop-loss order, is an order you place that instructs your broker to exit your trade if the price ever drops to a certain level. Think of a stop-loss order as a stop sign for your trade. If your trade ever reaches the stop sign—the price at which you would like to exit your trade—it immediately stops and exits so you can protect your money.
Guaranteed stops allow you to specify exactly how much you are willing to risk. Even though you are using great leverage, you still have the power to get out of a trade at any price you wish. You can’t say that about the stock market. Sure, you can enter a stop order to take you out of a trade if the stock starts to move down, but you have no guarantee that you will get out at a certain price.
It is really the luck of the draw for stocks. Not so in the Forex market. You have guaranteed stops under normal market conditions. There are some extreme events—like the outbreak of a war or extremely unexpected economic announcements—that may cause some slippage, but we have never personally experienced this.
MIND THE GAPS
If you’ve ever been to London and ridden the London underground, you are familiar with the charming reminder to “mind the gap.” Every time the doors of the trains open, a soothing voice comes over the loud speaker and tells you to “mind the gap.” This statement reminds you to watch your step as you step into and out of the trains because there is a gap between the train and the platform.
Of course, this is just common sense. Nobody wants to plunge a leg down a ravine between a concrete platform and a steel train. Unfortunately, the ravines that exist in the investment landscape are not as apparent and aren’t usually accompanied by courteous warnings of potential danger.
The key to developing and maintaining a well-balanced port- folio is learning how to mind and fill the gaps that are inherent in any market. Every market has gaps—the Forex included. But let’s say you’re investing in mutual funds in the stock market; you’ve made some great profits, but you’d like to fill some of the gaps. You will have to look outside the stock market to find the solution.
One gap that exists with mutual funds is that you can’t buy or sell them until the market closes for the day. This can pose a problem on days when the market is rising quickly because you end up miss- ing out on all of the positive movement.
If you are investing in the Forex market, however, you can fill that gap because you can profit from your Forex trades while you are waiting to get into your mutual fund trades. You can fill the same gap when the stock market drops quickly. You can make money in your Forex trades to offset the losses you would incur in your mutual fund trades.
The Forex market offers unparalleled advantages. Many other financial markets offer some of the same advantages, but the Forex market offers them all. The Forex is the solution for the gaps in three widely used financial markets: the stock market, the bond market, and the futures market.
Each of these markets offers the potential for making money, but once you see how they stack up against the Forex market, you’ll be wondering why you haven’t added the Forex market to your investing arsenal already.
The gaps you will see in all three markets are:
- Market hours
- Bear (downtrending) markets
- Analysis overload
Forex Market versus Stock Market
Since most of you are familiar with the stock market, this is a good place to start. The stock market has been the traditional investment of choice for most retirement accounts. The accessibility of the stock market and the fact that the United States has the best stock mar- ket in the world make it a logical place for serious investors. Along with outstanding benefits, the stock market also has a few inherent gaps that the Forex market can fill. Some of these gaps are particularly relevant to the active investor who trades frequently. Others are important to every stock market investor.
Gap 1: Commissions
Each time you trade one of your stocks (or mutual funds), either by entering or exiting a position, you incur a commission charge. In most cases, the charge is much greater if you actually need to speak with a broker to execute your trade. Imagine that you own several shares of Google’s (GOOG) stock, and you are concerned with the effects an upcoming earnings announcement might have on the value of your stock. You decide to call your broker to make a trade and ask for some advice. It’s going to cost you.
We took an informal poll of the largest online stockbrokers and found an average charge of $50 per trade in this situation. Those kinds of fees can add up. Plus, that fee was only for the sell order. Had you wanted to purchase the stock, you would have had to pay twice that amount, or $100. Now imagine how much it would cost if you wanted your broker to help you execute several orders on multiple stocks. You get the idea.
By contrast, almost every dealer in the retail Forex market offers commission-free service. Plus, you can talk to most Forex dealers in person as many times as you need to for free. Most Forex commodity trading advisors also operate on a commission-free basis. You should certainly do your homework to make sure that you are dealing with a dealer who is giving you the best treatment, but most offer comparable arrangements.
Gap 2: Market Hours
The U.S. stock markets are open from 9:30 a.m. to 4 p.m. Eastern time Monday through Friday. This is right in the middle of business hours. Because most retail stock market investors are at work during these hours, many cannot enter stock trades during the day when the stock market is open.
Instead, they have to “roll the dice” by placing orders when the stock mar- ket is closed and hope they will get into or out of their trades at a favorable price when the market opens the next day. If the stock opens at around the same price it closed at the previous day, you get a good price on your trade. If the stock opens at a much higher price than it closed at the previous day, you can get a very unfavorable price.
The Forex market is open 24 hours per day, from Sunday afternoon through the following Friday evening. Because the market is almost always open, you can enter your trades whenever you have time. And your orders will be filled within fractions of a second thanks to the multitrillion dollar volume the Forex market enjoys— even in the middle of the night. The exceptionally high volume that occurs on the Forex market also helps fill the next gap in the stock market.
Gap 3: Liquidity
Liquidity can be an issue when you are trading smaller stocks. Liquidity refers to your ability to sell, or liquidate, an investment you may be holding. If you can sell it quickly, the investment is a liquid investment. If you can’t sell it quickly, the investment is an illiquid investment. Imagine that you own a small-cap or micro- cap stock, and you need to exit your position quickly. Chances are you will receive a much lower price for your stock than you were anticipating. This is especially the case if the stock is experiencing bad news.
Mutual funds, as we mentioned earlier, are not liquid during market hours because you can buy or sell them only once the market has closed. Some mutual funds even have restrictions on when you are eligible to sell them without incurring penalties. The lack of liquidity found in mutual fund investing can keep you out of trades that are making money or keep you in trades that are losing money.
The Forex market has more liquidity (buyers and sellers) than any other financial market. This means that if you want to get into a trade, there will always be somebody there to sell it to you. And when you want to get out of a trade, there will always be somebody there to buy it from you. And you can do all this at a reasonable price.
Gap 4: Taxes
Taxes are one of the biggest concerns any stock investor must address. Making profits every month in your investing is wonderful. But if you do not have your investments sheltered in an IRA or other protected account, you will be charged a short-term capital gains tax on all your profitable trades that lasted less than one year. In some cases, this can mean a tax hit of more than 30 percent.
Most of you probably have the majority of your investments in tax-sheltered accounts. However, even tax-sheltered accounts have a gap. The drawback to these accounts, of course, is that you don’t really have access to that money—without penalties—until you are 591⁄2 years old. That’s right. If you take your money out of a tax-sheltered account before you are 591⁄2, you will have to pay an additional penalty—which currently stands at 10 percent. That can make a huge difference in your account balance.
By contrast, short-term Forex profits are taxed at a much lower rate. Each time you make a gain in the Forex market, as we outlined previously, 60 percent of your profits automatically qualify as long- term capital gains, while only 40 percent of your profits are considered short-term gains. And for those of you who are wondering, you can invest in the Forex market through a retirement account, like an IRA, as well. So, you can enjoy the best of both worlds.
Gap 5: Bear (Downtrending) Markets
Bearish stock market conditions are usually something that stock and mutual fund investors patiently endure. Some more advanced, and usually more wealthy, stock investors, however, are able to try to take advantage of bearish market conditions by shorting stocks.
Shorting a stock means that you: first, borrow a stock from your broker; second, sell that stock on the open market at whatever the going rate is; third, wait and hope the stock drops in value; fourth, buy the stock back (hopefully at a lower price); and fifth, return the stock plus interest to your broker. If the stock declines in value while you are shorting it, you make money.
If the stock increases in value while you are shorting it, you lose money. Shorting a stock is risky and expensive. Plus, not everyone qualifies to short stock. You have to have enough experience and enough money before your broker will even allow you to try to short stocks. Additionally, when you do short a stock you have borrowed from your broker, your broker charges you interest.
Perhaps the biggest drawback of shorting stocks is the “uptick” rule. If you see and want to take advantage of a stock that is dropping, you can’t just jump in and immediately start shorting the stock. You have to wait until the stock creates an uptick. An uptick occurs when the stock trades at a price higher than it was previously.
So if a stock drops from $50 to $49 to $48 to $47, it has not experienced an uptick, and you cannot short it. If, however, the stock rises back up to $48 after it has dropped to $47, it has experienced an uptick, and you can now short it. As you can imagine, most stocks that are falling tend to fall rapidly, and it is very difficult to find upticks. This can keep you out of a lot of trades even though you know the stock is going down.
Taking advantage of a downtrend in the Forex market is much easier than shorting a stock if you want to take advantage of a bearish market. It is as simple as this. If you think something in the Forex market is going up, you click on the “buy” button. If you think something in the Forex market is going down, you click on the “sell” button. How easy is that? You don’t have to qualify for any additional trading permission. You don’t have to ask your broker if you can borrow anything.
And, most importantly, you don’t have to wait for any nebulous upticks. If you see something headed down to the floor, you can jump in and take advantage of it any time you please. Imagine being able to take advantage of both uptrends and downtrends with just the click of a button.
Gap 6: Analysis Overload
The stock market offers an incredible selection of investments. There are literally tens of thousands of stocks and mutual funds to choose from. How in the world are you supposed to make an informed decision about which ones are the best to buy and which ones are the best to sell? Even your broker isn’t able to stay on top of every stock and every mutual fund.
To combat this problem, most of us have diversified our stock and mutual fund portfolios to cover a broad range in the market. This works pretty well because it lets you take advantage of movements in various segments of the market. It does, however, make it difficult to keep track of and load up on the stocks and mutual funds that are going to do well and dump the stocks and mutual funds that are not going to do as well.
The Forex market is much simpler to monitor. You really need to keep track of only eight different currencies. That’s right: eight. Even if you don’t have a lot of free time, you can keep track of something for which you need only two hands to count. (We talk more about the eight currencies you’ll need to keep an eye on later in the book.)
Forex Gap To ensure we are giving you a balanced view, and to emphasize that we are not issuing any type of Chicken-Little warning to pull out of the stock market, we want to highlight a gap in the Forex market that the stock market fills.
The overall Forex market is a trend-neutral market. This means that it moves up and down. But once you net out the ups and the downs, it is basically a flat market. The stock market, on the other hand is a predominantly up-trending market. This means that although the stock market fluctuates up and down, it has moved up over the long haul, as you can see in Figure 1.2. When a market is predominantly up-trending, it is generally easier to invest in for the long term without having to do a lot of thinking. You can just put your money in and trust that the market will go up.
However, this steady uptrend can also be counterproductive because it lulls investors into a false sense of security. If you believe the stock market is always going up, you probably are not going to pay as much attention to the market as you should.
You don’t have to look back any farther than the dot-com crash that started in 2000 to see this illustrated. Although the market has bounced back a bit since its low in 2002, it has still not recovered all its losses. (See Figure 1.3.) We are confident that the market will recover all its losses in the long term, but you could have saved yourself a lot of heartache if you had known about the Forex solution.
Keep investing in the stock market. Apply all the sensible rules and practices you have been taught. Then go one step further and really put the odds in your favor by minding the gaps with the Forex market.