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I’m looking into the forex (not looking to invest, just researching.) Suppose I am trading in hypothetical scenario where USD/JPY is trading at 10. Let’s say I perform the following actions:

  1. I deposit $200 into my account and exchange half into JPY. 100 USD, 1000 JPY.
  2. The rate changes to 20. I rebalance, converting $25 to JPY. 75 USD, 1500 JPY.
  3. The rate changes back to 10. I bring my USD balance back to the first balance of the $100. Now I have 100 USD again, but now I have 1250 JPY, a gain of $25 from step 1.

Why don’t more investors do this? Or do they? I would assume that it has something to do with fees/taxes making this strategy difficult to make money off of, or that the movement in rates isn’t enough to make a significant difference with this technique, or that the pattern is regulated against.

EDIT: I know the title isn’t very clear but other than saying “why don’t forex traders use this technique?” I wasn’t sure what to call this question.

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    Are you essentially asking "why don't traders just buy low and sell high?"? – not_a_comcast_employee Jul 30 '18 at 8:35
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    Heh! Dude, in your example all you are saying is: "I (correctly) guessed that the Yen was going to go up. I risked $25 on that. It worked and I made X." – Fattie Jul 30 '18 at 11:45
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    Your first sentence is good, because forex is not investing, it is pure speculation. It is for people who hate money as pretty much everyone loses. – Pete B. Jul 30 '18 at 12:43
  • This is a variant of dollar-cost averaging. – Acccumulation Jul 30 '18 at 21:28
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Well, your exchange rate changes are deeply unrealistic. But aside from that, there's another problem. You are assuming in step 3 that the exchange rate will return to the same position as it was in step 1. Sure, maybe that will happen. But if instead, it changed to an exchange rate of 30, you now have $75 USD and 1500 JPY worth another $50 USD, for a combined total of $125, or a loss of $75 USD over your original investment.

If you are sure the exchange rate will go up and then return to the original, your best option would be to skip step 1, convert all of your money from USD to JPY in step 2, then convert it back in step 3, doubling your money. But you simply don't. You don't know if the exchange rate will go up and return back. Or go down and return back. Or go up and keep going up, or go down and keep going down.

  • The exchange rates were meant to be easy for mental math rather than realistic, but I see your point. I suppose I was looking at this as a way that guaranteed small gains and lower risk (since your money is split 50-50.) However, I suppose stop orders mitigate risk as well. – Curious Blueprints Jul 30 '18 at 0:30
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    @CuriousBlueprints you can stop as soon as you get to the "guarantees gains" part, since no such thing exists. – hobbs Jul 30 '18 at 17:28
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    @hobbs minor correction: no passive use of money guarantees gains. The universally guaranteed "gain" is: produce products or services that people consider valuable and are willing to exchange for. :) – Wildcard Jul 30 '18 at 22:34
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    Or to put it differently, the expected monetary gain is proportional to the amount of work you do. – not_a_comcast_employee Jul 30 '18 at 23:18
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The key point is that your proposed strategy is unleveraged and is based, as you say, on rebalancing. This is a conservative, hedging-type strategy. It is unlikely to generate high returns (based on realistic currency movements). It might be appropriate, for example, to manage savings this way if you expect your future expenses to be half in the US and half in Japan (e.g., part of your family lives in each place, or you plan to move back and forth, or you're a company with offices in both places). You might get a small benefit from periodically selling high and buying low (the rebalancing effect), but need to make sure commissions don't outweigh this.

Most individual forex traders are engaged in speculation, not hedging. They take highly leveraged positions in futures. In that sense, they do "deal in both currencies at once". For example, they own JPY and are short USD (or vice versa). This has higher risk but the potential for higher returns.

  • I see what you mean about hedging. But I’m not sure about your other points. I didn’t put leverage in this hypothetical, but you could make this leveraged, could you not? – Curious Blueprints Jul 30 '18 at 0:33
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    @CuriousBlueprints To apply leverage to this portfolio (or any portfolio), you effectively have to borrow in some currency. This amounts to a short position in the currency you borrow. If you apply 2x leverage to your 50% USD/50% JPY strategy by borrowing USD, then you have a plain 100% JPY position. If you leverage more than that, you are net short USD and long JPY, and you are close to standard forex futures trading. But the rebalancing effect now works differently (against you), because it requires you to buy high and sell low, or risk being wiped out. This is the danger of leverage! – nanoman Jul 30 '18 at 4:44
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Any investment strategy, that can be described in three easy steps that anyone can understand, dealing in common financial instruments (currency, stock) will not be able to guarantee any gain, expect perhaps risk-free interest in a bank account.

The market already knows about all such tricks, and there is no arbitrage to be made.

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