Gambling on foreign currency

If you buy foreign currency, you are gambling on its exchange rate in the future. If it goes up, you make a profit. If it goes down, you make a loss.

If you lose on your position, you can decide to hold to that position, and hope that it will recover. It may recover or it may get worse (and increase your loss). This is gambling, so it is better to recognise its nature and think like a gambler.

It is all right to gamble, provided that you get the full benefit of any upside, and take the full loss of any downside. Make sure that your cost of the transaction is small, i.e. less than 0.3% for each side of the trade. The cost is the spread between the buying and selling price at the same time, and the additional charges that you have to pay to the bank.

There is another type of gambling that you should avoid. Do not gamble when the odds are loaded against you. If you gamble on a card game, do not gambling against a shark who has marked cards. He has superior information and is likely to win against you.

Similarly, you should not gamble on dual currency trade when the terms of the transaction are set by the bank who is taking the other side of the trade. You can be sure that the terms will be loaded in favour of the bank, who makes a profit when you make a loss.

One year ago, the Australian dollar dropped 30% against the US dollar over two weeks. The investors who were "long" on Australian dollars suffered a 30% loss. Those who were "short" on Australian dollars did not benefit from a 30% gain. They only get 2% or 4%. The rest of the gain goes to the bank who wrote the terms of the dual currency trade.

Are there circumstances where the bank will lose? Maybe, but the risk is small for the bank. They employ financial engineers to set the terms of the trade. These financial engineers look after the interest and profit of the banks. Guess who loses?

In some countries, the regulators ban this type of product as it is unfair to retail investors. But there is no such scrutiny in Singapore, so retail investors can be given unfair terms of the trade, i.e. "taken for a ride".

Lesson: never gamble on exotic products where the terms are written by the other party of the trade.

Tan Kin Lian