Why Aussie Traders Are Ditching Equities To Trade Foreign Exchange (FX)

It was revolutionary enough when the internet opened up access to trading the stockmarkets – but the $US6.8 trillion-a-day foreign exchange (FX) market is a much bigger pond in which to fish.

Australia is one of the most active retail markets in trading FX: according to a recent report from research firm Investment Trends, 54,000 individual investors traded FX at leats once in 2011.

Even though FX traders represent just 0.30 per cent of the Australian adult population, it is a relatively large market, says Investment Trends, given that the equivalent figure in the UK is 0.14 per cent of adults, and in Germany it is 0.03 per cent.

Investment Trends found that almost 30,000 Australians intended to enter the FX market in 2012.

Chris Weston, senior market analyst at contracts for difference (CFD) provider IG Markets, says there has been a “huge transition” of traders from the equity markets to FX over the last few years. “The equity markets have not been generating the kind of trends that traders like lately. A lot of our clients are trend-followers, they love to follow them – ‘the trend is your friend,’ and all that – and a currency in motion tends to stay in motion.

“Some of the popular currency pairs – for example, the euro/A$, euro/Swedish kronor, sterling/A$ – have given traders really nice trends, absolutely textbook, just the most beautiful trends you’ve ever seen, and it’s made it a lot easier to trade than the equity markets.”

Also, says Weston, the FX market is “open all the time,” which makes a big difference to traders’ ability to trade. “If you’re a share trader, you can’t get out of the trade overnight, you have to wait until the markets open again in the morning. But since the GFC, markets move mainly on headline risk, and most of that happens overnight. At the moment, for instance, most of the headline risk is coming from the market’s anticipation of bond-buying from the ECB, what’s happening from different central bank actions.”

If you’re trading Australian shares, he says, this can result in ‘gapping,’ where the price of a security opens lower (or higher) than the price at which it closed the previous night, without trading in between. “Say you’ve bought Fortescue Metals on the back of really positive comments coming out about China in our timezone, it’s up 4 per cent for the day, you’re in a profitable position when you go to bed, but you wake up in the morning and there has been a bad stgelopment in Europe, and your stock opens down 2 per cent. That’s been a problem for Australian traders,” says Weston.

“You can try to protect yourself with a stop-loss, but gapping won’t trigger the stop. Traders have realised that if some news breaks, the currency markets give you the ability to get out of your trade very quickly, without having to wait until the equity market opens next day.”

The only time that the FX markets are dormant is a five-hour period on London’s Sunday, between midnight Sunday and 5 am Monday in Australian standard time. Apart from that hiatus, traders can be active whenever they want.  Effectively, it is like the Australian Open tennis: each trading day has a day and a night session.

The most popular tools for currency trading are contracts for difference (CFDs) and margin FX (margin foreign exchange.) A CFD is a financial derivative that represents a theoretical order to buy or sell a certain amount of currency. Your profit or loss is determined by the difference between your opening price and the price at which you close your position. CFDs allow traders to leverage an investment in FX with a deposit of as little as 1 per cent – that is, the leverage is 100 to one.

In margin FX, the investor takes a simultaneous buying and selling position on a currency pair, and the margin FX provider is on the other side of the transaction. Margin FX offers greater leverage than CFDs: 400-to-one is common, and some margin FX providers offer 500-to-one leverage. The trader needs to have the margin in their account to cover the amount at risk. Traders in both CFDs and margin FX pay interest on a long (buying) position and receive interest on a short (selling) position.

Access to the greater leverage is also a major attraction to traders, says Weston. “Trading with that kind of leverage can be very dangerous: you need to be aware of those risks, always use stop-losses and manage your risks appropriately. To manage the leverage you just take the position size down.

“You have to look at how much you’re prepared to lose on each trade – on a sizeable account, you might want to potentially risk 2 per cent of your total account. You’re not going to get every trade right, so you manage your money – you take your size down to manage the risk,” says Weston.

Andrew Barnett, professional trader and founder of LTG GoldRock, an Australian company specialising in margin FX trading, says another big driver of why FX has boomed among retail clients is the low barrier to entry. “If you compare FX to the stock market, for example, with most FX brokers you can open an account with $300 – some of them with $100, but it doesn’t get you far. And you can trade 10 cents a point, so every time the A$ moves one point, you make or lose 10 cents. People tend to like that because they can have a little dabble in the market.

“In equities, if you wanted to trade BHP, you can trade it with cash, open up a CommSec account, you’ve got to have $1000 in there to buy or sell anything, you pay $20 to get in, $20 to get out, the barrier to entry is a bit higher. In FX on a very small position you might be paying 20 or 30 cents for the brokerage, and you only pay once.”

Where some people do really well at FX trading, says Barnett, is where they start off really small and gradually grow their account. “The ones that don’t do well put too much money in there and trade with a skill-set they don’t understand. They don’t understand how to risk money to less than one per cent a position – they don’t understand how to manage risk.”

Barnett says an institutional trader or a professional trader won’t risk more than one per cent per position. “Whereas, the average retail trader opening up a retail FX account, you can pretty much be guaranteed that they’ll be risking anywhere between zero and 100 per cent on a position, because they don’t really know how to manage risk properly,” he says.

Weston says the skill-set required is no different from trading equities. “You’ve got to understand what you’re trading, understand the risks and volatility around that, understand what feeds in to the price action – very similar sorts of things. If I’m trading CBA, for example, I’ve got to understand what makes that stock move.

“Most of that applies to the FX market, as well. What makes a currency move against another? Will a piece of economic data impact that currency, and how? Will it be good for that currency or negative, and what’s the reaction likely to be? Where are my technical entry and exit points? A lot of it involves the same things – FX is just a bigger, deeper and open-longer market,” he says.