Your Money & You – February 2011

Forex trading – at your own risk

Many of you travel the world through your deployments and personal travel and are probably very experienced at managing foreign currencies. What you might not realise is trading foreign currencies, or forex trading, is a very risky form of investing. In one trade your investment can turn into thousands of dollars of debt .

What is Forex?
Foreign exchange trading is the practice of buying and selling foreign currencies to make a profit. It is possible to trade in this way because foreign currency exchange rates move in value when compared to each other. Foreign Exchange is also known as Forex or FX trading.

An example of the simplest form of foreign exchange is when you're deployed overseas and sell Australian dollars to buy foreign currency. When you return home, if the value of the Australian dollar has gone down relative to the currency of the country you came from, then you will get more money back per dollar, less any fees, commissions and profit margins applied by the bank or foreign exchange provider.

Foreign exchange markets work in a similar way but on a larger scale.

The dangers of leverage
Most forex trading products are highly leveraged. This means you only have to pay a fraction (for example, 0.5%) of the value of your trade up front, but you are still responsible for the full amount of the trade.

For example, a $50 investment could let you place a $10,000 forex trade. If the value of the trade dropped by 0.5% to $9,950, you could lose the original $50 that you invested. If it fell further, you may have to pay much more than your original investment.

You could even be liable for the entire $10,000 – that's 200 times your original investment – unless you close out the trade sooner before the losses become so extreme.

Risks of forex trading
To successfully trade in forex you need to understand the economic conditions of each country whose currency you are trading, and how those conditions affect the relative value of those currencies. This is extremely difficult because so many factors come into play including politics, economics and market forces.

Forex markets are very risky because:

• you could lose more money than you put in, when the trade is leveraged;
• there is a huge volume of trading ;
• you're dealing with foreign traders, laws and cultures;
• markets are open 24 hours a day 5 days a week, making it hard to track your investment; and
• markets are impossible to predict because so many factors affect exchange rates.

In order to trade forex successfully you need:

• extensive trading experience in shares and other investments for a long period of time;
• to know how forex works in detail;
• to read the product disclosure statement and discussed the risks with your financial adviser; and
• the financial capability to afford to lose more than the amount you invested.

Forex providers
There are many providers and types of forex trading products. Some that you may see advertised are:

• Forex contracts for difference (CFDs)
• Margin forex trading
• Spot forex contracts
• Forex options.

Different types of forex trading products involve different risks. If you are looking at Forex CFDs download our investor guide, Thinking of trading contracts for difference (CFDs)? from www.fido.gov.au.

There are also many software programs available which claim their programs can let you know when to make trades or let you manage your forex trades online in an easy and simple way. Remember, forex trading is never simple so don't rely on a trading system that tells you it is.

Also be wary of marketing promises that suggest that by using a particular product you will get access to better exchange rates or that say it is easy to make money trading forex. Some providers let you trial their trading platform for free initially – but it is always different when your money is on the line.

Trading in international currencies is never easy and requires a huge amount of research and monitoring if you are to be successful. Even the most skilled and experienced investors cannot reasonably predict currency movements. So before investing in forex or any other investment, always consider our six steps to investing between the flags.

• Understand some key things about yourself
• Understand some key things about investments
• Develop an investment plan
• Decide how to invest
•  Implement your plan
• Monitor your investments

For more information on investing visit ASIC’s consumer website, FIDO at www.fido.gov.au or call 1300 300 630.

E-mail ASIC with topics that interest you at ADFcolumn@asic.gov.au.

Tony D'Aloisio BA LLB (Hons)
Chairman
Australian Securities and Investments Commission

Where to next with house prices?

The housing boom which began in 2009 and ran for most of 2010 has cooled.

Some experts are arguing that rapid immigration, the generally buoyant economy and supply shortages in construction caused by too few re-zonings and tight credit will see house price increases return to double-digit growth in a year or two.

Other economists argue that housing has become unaffordable for many would-be buyers and the impact from the under-supply of housing has already incorporated in average house prices.  These will see house price increases delayed for two or three years.

Another view suggests that house prices bubble will burst because too they’re too high relative to average incomes, rents, the long-term trend in house prices and/or house prices overseas.  The high level of debt and the predominance of variable-rate mortgages leave existing borrowers highly vulnerable to further increases in interest rates.

The housing market in Australia has some unique features relative to overseas where some large reductions have been seen (US, UK and Ireland).  For example we allow negative gearing on investments, including housing.

Are we on course for a housing crash -- or an adjustment that is extended and gradual?

At the end of the 1980s average house prices seemed overvalued especially with housing interest rates rising to 17 per cent (presently 7.7 per cent) and unemployment going above 10 per cent (5 per cent), the housing market didn't collapse.  For a run of years thereafter, average house prices were fairly flat.  Housing affordability was re-established through the trend increase in earnings and the cyclical decline in interest rates.

Some experts are suggesting we might see house prices adjust in a similar way.  They argue that we seem to be at the stage of the investment cycle where, on average, residential property is likely to underperform shares for a while -- just as happened during the 90s and in the middle years of the past decade.

For people looking for a house to live in, the messages would seem to be:

• put a low probability on prospects of an impending housing crash that would provide housing bargains of a lifetime
• recognise that a soft housing market gives opportunity to prospective buyers more time to research the suburbs or towns they're interested in
• given the structure of interest rates, consider taking out a part of the mortgage as a fixed-rate loan as protection against adverse moves in interest rates

Shane Oliver of AMP Capital Investors said in a recent publication, "Over the long term, the returns from housing and shares tend to cycle around each other at similar levels . . . While housing is less volatile than shares and for many seems safer, it offers a lower level of liquidity and diversification. The bottom line is, once the similar returns of housing and shares are allowed for, and these characteristics are traded off, there is a case for both in investors' portfolios over the long term."

Free Seminars anywhere in Australia

In addition to its commitment to financial education programs in ADF training curriculums, the Consumer Council is happy to provide expert speakers free of charge on a range of financial topics to any ADF unit in Australia.

For more information contact us via our website at www.adfconsumer.gov.au. (www.adfconsumer.gov.au).