Investing at the edge: the lure of high-risk trading
Every serious investor has felt the lure of high-risk trading at some point in their lives.
It is not hard to see the attraction – the chance to make big money in a short period of time.
Today it is particularly tempting, when low-risk investments such as cash and bonds offer a near-zero return. Why leave your money to die a slow death in the bank when you could be trading gold or obscure foreign currencies, shorting the price of oil or copper, or investing in frontier markets?
But if making a small fortune from high-risk investing was easy, everybody would be doing it.
Sam Instone, the chief executive of chartered financial planners AES International, says this is speculation, rather than investing. “It may be exciting but just like gambling, speculation is an amazing way to lose money quickly.”
Too many people are seduced by the get-rich-quick dream. “They jump in, taking on high levels of risk often at precisely the wrong times – buying gold at the peak, Bitcoin after it’s jumped US$30 in an hour, or investing in penny shares that turn out to be dead cats that will never bounce.”
But his warning will not stop the risk-takers from pitting their wits against the market, and provided you can limit the downside it may be worth taking a chance with a small part of your wealth in the hope that it will grow to be a lot larger. Here are some of your options:
Many UAE residents will feel an instant affinity with the concept of currency trading. They are used to juggling foreign exchange, for example, earning dollar-pegged UAE dirhams, and sending them to their home country in Europe, India, the Middle East, Australia or wherever.
So why not turn that knowledge to your advantage by trading currencies online?
It is quick and easy to set up an online trading account, and you can also use it to hedge against any existing currency risk when transferring earnings overseas or buying a foreign property.
There are plenty of currency trading websites open to UAE would-be traders including Forex, FXPro, Xtrade, HotForex and XM.
You can trade on almost any currency in the world, although most stick to the so-called “majors”, notably the US dollar (USD), British pound (GBP), euro (EUR), Japanese yen (JPY), Swiss Franc (CHF) and Canadian dollar (CAD).
Currencies are quoted in pairs, with EUR/USD one of the most widely traded currency pairs of all.
Fawad Razaqzada, a market analyst at Forex.com, says today the key global trade is the US dollar. “The Federal Reserve is the only major central bank in the world that is looking to increase interest rates, and that is driving the dollar higher,” he explains, adding that currencies typically strengthen when local interest rates rise, as investors can secure a better return.
“The Bank of Japan, European Central Bank and Bank of England are far more dovish, and the dollar is likely to remain strong unless the US economy suffers a shock downturn,” he says, adding that investors must remember this is short-term trading, not long-term investing. “There is a daily financing charge and it can soon add up if you hold a losing position for a long time. It is also financially and emotionally damaging, you can be waiting a long time for your trade to turn good.”
It makes more sense to trade on short-term events, for example, an interest rate decision, economic data, elections, anything whose outcome can affect the relative value of a currency pair.
However, Mr Razaqzada warns that it is really difficult to make money unless you know what you are doing. “You are against experienced investors, who have larger funds than you, can absorb their losses better, and hold a position for longer.”
Contracts for difference
If you want to add a little edge to your investment portfolio, contracts for difference (CFDs) allow you to make money regardless of whether share prices are rising or falling. But they are a high-risk investment, because you can lose more than your original stake.
They are derivative-style investments that were originally used by hedge funds and institutional investors to hedge the risk on their portfolios, but can now be traded affordably by private investors through a number of online platforms.
They aren’t for novices, dabblers or worriers but should only be considered by serious investors with deep pockets, strong nerves and a robust attitude to risk.
A CFD is halfway between an investment and a gamble. You aren’t physically buying the stock or index itself, instead you are speculating on how you expect the price of the underlying investment to move.
A CFD is a contract to pay the difference between the starting price and the closing price of your chosen investment. There is no fixed expiry date, you can close your trade at any time.
You don’t have to pay full market price for your chosen instrument, you could buy, say, $10,000 of shares while only putting down $1,000. As a leveraged investment, your potential returns are far greater than the cost of your original investment, and so are your potential losses.
You can set up stop-losses to minimise the downside, but these can backfire if they trigger too early.
Kyp Zoumidou, the head of the Dubai office at IG Group, says that CFDs can be used alongside thousands of underlying products including gold, oil, currencies and global stock markets such as the S&P 500 and FTSE 100. “Oil and gold are the two most commonly traded commodities using CFDs. So if you thought the price of crude is going to fall or rise sharply, a CFD could help you profit.
“You could have made money out of the US election by shorting the Mexican peso, which fell sharply on Donald Trump’s shock victory. Similarly, you could have bet on the euro rising against the pound after Brexit, or German car manufacturer Volkswagen’s shares falling after the emissions scandal.”
You can trade CFDs in the UAE, through global sites such as IG Index, Saxo Bank, IFC Markets and ADS Securities.
Gold is often described as a safe haven for investors, but the truth is it can be highly volatile.
The gold price is down almost 8 per cent in the last 30 days, knocked back by the rising value of the dollar, and trades 30 per cent lower than it did five years ago. At the time of writing, it languishes at $1,189. Today’s price is $1,168.
However, it remains one of the most rewarding investments of the millennium, having risen 339 per cent since January 2000, according to goldprice.org.
Investors cherish gold because it moves in the opposite direction to most other investments.
This “inverse correlation” means that if shares, house prices or the US dollar crashes, gold typically will soar, as nervous investors rush for cover.
Right now, there are good reasons to invest in gold as protection against global economic risks, says Gary Dugan, the chief investment officer for wealth management at Emirates NBD. “If this Sunday’s referendum in Italy goes against the government it could put Italy on a path to leaving the EU, hitting the euro.”
Gold is at its most vulnerable when the global economy is ticking along nicely, Mr Dugan says. “However, high levels of global indebtedness, ageing and elevated levels of conflicts are likely to support the gold price.”
In Dubai, you can buy coins and gold bars direct from suppliers or gold jewellery shops, but this has its downside, Mr Dugan says. “Physical gold needs to be held in a secure location, which means you will incur potentially significant costs of buying a safe and taking out insurance. Also, large holdings of gold are also not particularly portable.”
London gold firm Bullion Vault stores your gold in vaults in London, Zürich, New York, Toronto or Singapore, so you never take delivery of the metal. And the Emirates NBD Gold Investment Account allows you invest in a simplified electronic form.
Alternatively, get exposure to price movements by investing in a low-cost exchange traded fund (ETF), sold by most online fund platforms, independent financial advisers and stockbrokers.
John Blowers of fund tracking site TrustnetDirect.com, says: “The Physical Gold ETF is a simple, cost-efficient way to access the gold market by providing a return equivalent to the movements in the gold spot price, with an annual management fee of just 0.39 per cent, plus dealing charges.”
The ETF is up 33 per cent over the past year, but down 14 per cent over five years.
Alternatively, buy a mutual fund that targets gold and other commodity stocks, notably BlackRock Gold & General, which is up 68 per cent over the past year, but down 20 per cent in the past three months, a mark of its volatility.
Or invest directly in individual gold mining stocks such as London-listed Fresnillo and Randgold Resources, which are up 71 per cent and 41 per cent respectively over the past year – but be warned, they could fall just as sharply if gold sentiment reverses.
Investment experts will tell you that investing in smaller companies is riskier than investing in larger stocks. However, over the long run they do tend to outperform.
For example, over the past five years Japanese smaller companies have returned 137 per cent, against 91 per cent for the country’s stock market as a whole. UK smaller companies have returned 102 per cent against market growth of 75 per cent, and European smaller companies have grown 113 per cent against 90 per cent.
The truly brave will invest in individual company stocks, but this is particularly risky. The oil sector is a particular favourite, with many looking to buy smaller explorers in the hope that they will strike it rich on a spectacular oil find. However, after the oil price crashed, many have seen their dreams turn to dust.
Tom Anderson, a private client investment manager at advisers Killik & Co, advises having a well-diversified portfolio before you take this route.
Investing up to 5 or 10 per cent of your overall portfolio can “add a bit of cordite” Mr Anderson says. “Individual stock-picking is certainly the purest form of investment, provided you have the time and interest to pay close attention to your holdings, and can stomach the volatility of individual equities.”
When buying individual companies, you have to accept that you could lose some or all of your money. For every winner, you are just as likely to back a loser.
Spread your risk by investing in a smaller companies mutual fund, run by a manager and research team with plenty of experience in this sector, Mr Anderson says. “These traditionally outperform funds investing in larger companies, although with more volatility along the way.”
Mr Anderson tips the North Atlantic Smaller Companies investment trust, which has returned an astonishing 160 per cent over the past five years, according to trustnet.com.
Emerging markets were the No 1 investment play of the early “noughties”, with global money pouring into Brazil, Russia, India and China as the Brics threatened to play catch-up with the West.
Performance slipped after the financial crisis, but Mark Mobius, the executive chairman of Templeton Emerging Markets Group, says the outlook is starting to improve. “Emerging market countries are still behind their developed market counterparts, but we expect strong growth prospects over the long term.”
The big concern is that they could be hit by a stronger US dollar, as many countries such as China have large dollar-denominated debts, which will become more expensive to repay if the greenback strengthens.
Ashley Owen, head of investment strategies at AES International, says emerging markets are higher risk but do not necessarily guarantee a higher return. “They are illiquid, corporate governance can be poor, governments have too much control over markets and may also set capital controls. You should still include them in your portfolio, but only a relatively small weighting.”
Mr Owen tips BlackRock iShares MSCI Emerging Markets ETF, which has delivered a total return of 37 per cent over five years and 27 per cent over the last year.
BlackRock Frontiers investment trust is also worth considering. It invests in the next generation of growing countries, such as Argentina, Pakistan, Romania, Kazakhstan, Vietnam, Kuwait, Saudi Arabia and Egypt. It is up 130 per cent over five years and 29 per cent over the past 12 months. As always, past performance is no guarantee of future returns.
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Updated: December 2, 2016 04:00 AM