Currency speculations on Forex are short transactions ranging from a few minutes to a month, based on technical and news analysis. In contrast to medium- and long-term investments, the fundamental approach is rarely used in short-term trading. Such speculative transactions are focused on getting quick profit.
Traders who decide to join the “cohort” of short-term speculators need to consider a number of important features of speculative currency trading. The described features relate to speculation and are partially true for medium-term investments using any kind of analysis - fundamental, technical or news.
Regular speculation requires a lot of free time. The shorter the average retention period of the position, the minimum period is in scalping, and the larger the number of open transactions, the higher the time costs. In this case, it is necessary to take into account the additional time spent on market analysis to search for potentially attractive assets and transactions.
Often, speculators do not have time for other activities, unless it is a relatively passive income, such as owning a business without participating in management. It's simple: without enough free time for speculation, a trader cannot count on stable and regular earnings.
A trader can make up to several hundred transactions, and scalpers – thousands of transactions, in one month. The load may increase due to several simultaneously opened positions. All this requires the trader to have maximum concentration and operational actions to fix profit / loss for each transaction.
Such conditions exert psychological pressure. After all, it may happen that during the day it is necessary to fix several losing positions. Even subject to risk management and the principles of an individual trading system, such situations provoke a loss of emotional control. As a result, the inexperienced speculator begins to make mistakes in trying to win back or prove the rightness of the market. With long-term investments, such an effect is minimal.
The smaller the size of the deposit for speculative trading and the lower the risk of transactions, the less likely are periods of emotional instability, which lead to a series of rash and intuitive trading decisions.
High discipline requirements
It is logical that a large number of short-term transactions provokes more trading errors, which is due to the following reasons:
- decreased concentration in conjunction with increased psychological stress;
- a false sense of the low value of a particular transaction, although it is enough to fail to fix a loss once in time, and this will lead to a significant loss of the deposit.
Strict adherence to the principles of the trading system will minimize rash transactions over a long distance. But for this you need to gain experience. It’s better to fill up cones using a small “risky” deposit or to select a small portion of the portfolio specifically for speculative transactions.
In long-term investment discipline requirements are much softer. The investor has significantly more free time to monitor and rebalance the formed portfolio in time. That is, the factor of time and operational decisions is not critical.
Instability of financial result
Compared to long-term investments, the average monthly volatility of speculation returns is potentially higher.
- Firstly, the majority of stocks and the stock market as a whole tend to adhere to the trend, which smooths the dynamics of the portfolio value, especially while the majority of stocks in the portfolio are in trend. There may be several long-term trends throughout the year, but this does not negate the smoothing effect. The speculator often catches local trends, or makes irregular transactions on a global trend. Here the smoothing effect does not work.
- Secondly, a larger number of transactions opens the possibility for higher earnings, but the risks are also higher, compared to a stable portfolio. For example, the speculator predicts corrections during a growing trend, first fixing the position at the highs, and then reopening the transaction during the correction - the total return will be higher than the portfolio. In losing trade, the speculator, for example, often buys securities, which subsequently fall. In an extremely negative scenario, purchases will take place at local highs. In the case of a stable portfolio, the decline is limited by several weak securities, and corrections soften the final drawdown.
It turns out that even without using leverage, the statistical risk, volatility of profitability, of speculation is rated higher in comparison with investments.
Long-term investors can expect to receive dividends on shares included in the portfolio. At the same time, speculators usually do not receive dividends in their pure form. Of course, dividends are set by the market at the current price of securities. Nevertheless, the shorter the retention period of a speculative position, the less the dividend component in the transaction profitability. Scalper speculators close deals within a few minutes, so any deal and final result for the year does not include the effect of dividend payments by companies in principle. Formally, this is a lost profit.
The described features can be attributed to the difficulties or disadvantages of short-term speculation. However, if a trader plans to use exclusively technical and optionally news analysis, then speculative trading is the optimal solution.
Also, some traders feel discomfort while holding long-term positions. It is easier and more convenient for them to take profit / loss over a short distance, that is, to work with short-term positions. Speculation is preferable for such traders, despite the attendant features and complexity of the speculative approach.
Some tips for short-term speculators
When you make transactions, do not forget to take into account the risks and the possible implementation of a negative scenario.
To save money, start a personal budget. Make a list of your regular monthly expenses: food, housing and communal services and loans, clothing, service subscriptions - prioritize items and cross out the last items for the coming crisis months. If you stick to this list and stop making impulsive purchases, then you will be able to save.
Do not invest all your money in one financial asset: if it falls in price, you will lose everything at once. Distribute your savings across different assets. For example, invest 40% in a bank deposit, 30% in stocks of companies from different industries and countries, 20% in bonds, 10% in gold. Invest in ETFs: this way you will distribute funds between several assets at once. For example, stocks of the FXUS fund can be bought on the Exchange. The fund invests in securities of 600 American companies, and when you buy one share of FXUS, you will distribute your money for all these securities at once.
Part of the money can be invested in classic defensive assets, including gold. In March 2020, there was a temporary liquidity crisis, and even gold quotes fell below $1500. However, it is difficult to find a replacement for gold as a reserve asset. Since investing in gold does not involve coupons or dividends, investing in shares of gold mining companies may be more interesting.
Now it is better to invest in bonds issued by the Central Banks rather than bank deposits. Yield to maturity on bonds exceeds the average rate on deposits in the 10 largest banks. For example, on March 16, the yield to maturity of two-year government bonds is about 7.4% per annum.
If you are not prepared to take risks, invest in structural products with full capital protection or structural products for which returns are higher than at the bank and the maximum possible loss is limited.
Do not buy currency for all your money
Today, the price of oil is almost equal to the cost of many oil production projects in the world: companies sell oil at the same price as they produce. Prices are unlikely to be long below $30 per barrel, as this will lead to a reduction in production. Most likely, the pressure of oil on many oil-backed currencies will turn out to be short-term, and the process of depreciation of them has partially already occurred.
Many foreign exchange rates depend on the spread of the COVID-19 coronavirus pandemic. Following the example of China, it takes several months to stabilize the situation in the country: by the end of May, the spread of the virus will begin to weaken in some countries, investors will begin to return their money to securities of emerging markets, and the local currencies will strengthen. Therefore, the purchase of currency in the long term will not be beneficial to the investor.
If you need currency right now, open a brokerage account and buy currency directly on the exchange. It is there that banks buy currency, and then sell it at their extra charge. It is more profitable for banks to set the purchase price of the currency below the Central Bank rate, and the sale price is higher.
Author: Kate Solano for Forex-Ratings.com