Forex Trading Isn't Right for Average Joes

LET'S JUST GET this over with: Get-rich-quick schemes are always too good to be true. Always. That means those TV and radio come-ons about making a six-figure income working from home are at best a waste of time and at worst a waste of your hard-earned income.

Having established that point, let's now say that among those improbable pitches the ones promising riches by trading foreign currency are among the worst. It's no secret that forex trading is a haven for scoundrels. So much so, in fact, that the North American Securities Administrators Association and the U.S. Commodity Futures Trading Commission maintain a standing warning about fraud.

According to the NASAA and CFTC, typical scams promise huge returns from forex trading with little or no risk. The pitches vary but often center on the power of using leverage to turn small currency bets into big paydays. In reality, the checks you write are more likely to finance a new Ferrari for the scammer than a dollar/euro futures contract.

The pitfalls of foreign exchange aren't limited to being hood-winked by con artists. Even when legitimate, forex trading is the antithesis of long-term, buy-and-hold value investing that has proven itself to be the best strategy for average investors (and made the most visible adherent to the approach, Warren Buffett, worth about $60 billion). As NASAA, an organization of state securities agencies devoted to investor protection, cautions: "Even when purchased through the most reputable dealer, forex investments are extremely risky."

One of the more pernicious aspects of forex trading for retail investors is that the market so obviously appeals to our worst day-trading instincts. Not only is it an over-the-counter market, but it almost never closes, with trading running 24 hours a day Sunday to Friday. Only Las Vegas casinos keep longer hours. If you're prone to gambling addiction, then forex trading could be your financial demise.

Even worse, legitimate forex trading is presented as simple, fun and easy to learn. In reality, it's extremely complicated. The market averages more than $3 trillion in turnover a day, according to the Bank for International Settlements, the central bank for global central banks, equivalent to roughly a quarter of U.S. GDP. Meanwhile, just a scant 5% of that turnover is due to foreign trade. The rest comes from speculation by professional traders. Dip a toe in this water and you're already swimming with sharks.

As for the trading itself, it's frenzied and complicated. Currencies trade in pairs, as in you buy dollars and sell euros (or yen, or pesos, or some other currency) simultaneously, betting on relative outcomes that are influenced by a varied and global list of factors. Trade balances or imbalances, central bank interest rates, domestic and foreign policy statements — if you thought day-trading stocks was tricky, well, the level of unpredictability here is of another order. At least in Blackjack you can learn to count cards.

Currency exchange is an important and legitimate investor consideration. American companies doing lots of business overseas, for example, are benefitting handsomely from the weak dollar. Buy U.S.-based multinationals like Boeing or Coca-Cola to potentially reap those rewards. And if you absolutely, positively must play a hunch on a specific currency, stick with exchange-traded funds, which are liquid, transparent and regulated. Rydex offers several CurrencyShares ETFs that track everything from the Australian dollar to the Swiss franc.

Forex Fraud Warning Signs

Promises that sound too good to be true. Get-rich-quick schemes tend to be frauds. Unsolicited phone calls offering forex investments, especially those from out-of-state salespersons or companies you never heard of. Companies that predict or guarantee large profits. Companies that promise little or no financial risk. High-pressure efforts to convince you to send or transfer cash immediately. Anyone who won't give you their background.

Sources: North American Securities Administrators Association, U.S. Commodity Futures Trading Commission