A guide to investing in currency: a sensible approach to trading and investing in managed forex accounts.

For many people, currency investments are still widely misunderstood, and are often associated with excessive risk-taking, high amounts of leverage and internet scams. Much of this has to do with the lack of regulation in the forex market, which has lead to the rise of many unscrupulous firms that have tainted forex’s overall reputation.

This depiction of the forex market, however, is far too simplistic, and not very accurate. The currency market has many advantages that make it a very attractive investment opportunity – you just have to be able to distinguish how to best approach this daunting trillion dollar market, rather than plunging right in.

For most investors, the choice is between learning to trade themselves or having their money managed by someone else. Over the last few years, the trend has been towards increasingly small account minimums, which has lowered the barrier for entry significantly. The prospect of trading for yourself can be extremely enticing, but should not be approached hastily. For the uninitiated, the forex market can be abruptly unforgiving if you aren’t exercising appropriate risk management.

If you are looking to learn to trade independently, the most important factor is to make sure that you have an underlying ‘edge’ that is at the heart of your trading strategy. Without a concrete edge, your trading approach – even if it is consistent, which is a whole other topic - amounts to nothing more than glorified gambling.

Many traders simply try to derive profit from the market by throwing together various technical indictors blindly, with no basis for what they are doing. This is an exercise in futility, and will only lead to frustration and blown accounts. Instead, approach the task by learning as much as you can about the market – how it moves, why it moves, and how it reacts to things.

Make sure that you develop a solid understanding of market dynamics – where you can understand why certain things ‘tend’ to happen at certain times more than other things – and then you can construct a strategy around that premise. But remember, you need to have the premise first; everything else – all the indictors and lines – are merely tools for you to use to capture it.

The other option is to have your account professionally managed. For the average individual investor, the most accessible option is to open a managed forex account with a Commodity Trading Advisor (CTA). As with any industry, there are many different options, and you should investigate carefully to make sure that you are investing with a reputable firm.

Here are some key things to look out for:

• Do they take custody of the money themselves or is it held at a reputable third party custodian?
• Do they allow you to view all of the activity in your account, at least on a daily basis, but preferably live?
• Do you have access to your money or is it locked up for long periods of time?
• Do they clearly highlight the risks of their investment programs or do they simply promise high returns with little or no risk?
• Do they have a disclosure document, detailing all potential legal and risk considerations?
• Are both the CTA and the custodian domiciled in a country where you would feel comfortable sending your money?

In addition to these considerations, you should also have an understanding of how your money would be invested and the levels of volatility that you are likely to see in your account.

There are many programs that can produce impressive returns, but investors don’t often realize that that often comes with a significant degree of volatility throughout the year.

You should only invest in programs where you would be comfortable with the worst historical drawdown for that the program.

You should also have an understanding of how much total risk the manager is taking on, and how their programs would be able to handle unexpected ‘black swan’ occurrences, such as a terrorist attack or another significant event where the markets may react sharply.

Do they have a consistent investment methodology, and is it adaptive enough to function across a variety of market conditions? These are all questions that you should have an understanding of before investing.

Whatever you decide to do, a sensible currency investment will add greater diversification to most portfolios, smoothing your overall level of volatility. Most forex investment funds are absolute return oriented – meaning that they take both ‘long’ and ‘short’ positions in the market.

This means that they are uncorrelated to most conventional ‘buy and hold’ strategies, potentially decreasing total portfolio risk if incorporated wisely.

Finally, many investors get overzealous when investing in managers that sound ‘hot’. You should remember that there are always risks and that real forex investments aren’t likely to be paying you a fixed amount of interest with principal protection. If it sounds like a bond in its guarantees, but offers disproportionately high returns, you should approach with a strong degree of caution.

About the Author

Christopher Muir is President and CEO of Invariant Capital Management, a New York based managed currency fund. Invariant specializes exclusively in robust, systematic trading strategies, focusing primarily on the G10 currencies.