In the first article of this series, we defined what non-bankable assets are and went a step further to explain why this asset class is a unique opportunity for wealth management. This article will discuss how foreign exchange (FX), derivatives, and commodity markets work. We will also discuss the hidden dangers of leveraged investments and why you should not stick to more traditional asset classes.
Investing in Foreign Exchange, Derivatives, and Commodity Markets
It is undeniable that investing nowadays and generating good returns, without severe risks, is almost impossible. The explosion of opportunities for potential investors often confuses the density intricate in each of them.
Most people find the risks of direct equity investments out of proportion to their prospective returns and seek alternative sources of wealth creation. Nevertheless, the problem exists in detail. For instance, it is possible to invest online using a personal account in the FX, derivatives, or commodity markets (e.g., using eForex trading platforms from companies like Saxo Bank or Swissquote).
Such platforms allow retail investors, without previous experience, to access such marketplaces by easing relatively small initial investments. However, the possibility can be highly risky for individual investors, despite the dominant perception that FX investments have a lower risk compared to investing directly in equity. These platforms often provide a high leverage, and unexperienced investors can quickly gain significant knowledge over time as they become inspired by initial success.
The Hidden Dangers of Leveraged Investments
Investors employ leverage to gain from the fluctuations in exchange rates between two different currencies in FX markets. Because currency prices typically change by less than 1% over a trading day, most brokers offer very high leverage ratios.
Nevertheless, the opportunity provided by leveraged trades comes at a price, potentially very high, which should not be assumed. If the currency underlying one of the trades swings in the opposite direction to the investor’s expectations, the leverage intensely magnifies the losses. To avoid falling into severe problems, FX dealers, mostly, create harsh trading rules that include the application of stop and limit orders to regulate potential losses. These rules call for a certain level of experience and a time-commitment held in reserve for more experienced traders. It is by no means easy.
Should You Continue Sticking to More Traditional Investments?
Investing in the most common asset classes is simply not as profitable as it once was. Regarding Fixed Income Investing, a portfolio of safe government bonds is unlikely to offer the previous years’ rates- and in some instances, little more than retail bank deposit rates.
The situation has made even the most risk-averse investors to look for new ways to “buy” risk to finance themselves over the long term. This has caused many investors to become even more exposed to the equity markets’ upheavals- a situation that commonly applies to many pension funds nowadays.
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