Swine Flu Makes Forex a Sucker's Bet

Among the immediate lessons to be learned from the market's reaction to the swine flu outbreak is that currency trading is a sucker's bet for average investors. The massive 24-hour global currency markets move so quickly and so relentlessly that foreign exchange trades are really best left to the professionals.

Case in point: The U.S. dollar rose sharply Monday on fears the swine flu that originated in Mexico could become a global epidemic. That's not a surprise. The almighty dollar -- like Treasurys and gold -- is seen as a safe haven in times of distress. The Mexican peso, naturally, sold off.

Cut to Tuesday and the trade was over. The dollar fell and the peso gained ground. So what happened? Partly it's that the currency markets had a knee-jerk reaction to the flu news and got ahead of themselves, says Michael Woolfolk, senior currency strategist at Bank of New York Mellon.

"This is not yet a pandemic," says Woolfolk, "and a lot of things are going to have to happen before we get there. The correction set in Tuesday and we need further confirmation that it is indeed a pandemic before trading it like a pandemic."

Take it as a textbook example of one of the more dangerous pitfalls for amateur forex traders: Currency markets have very, very short attention spans. Tuesday's better-than-expected consumer confidence and housing data made Monday's swine-flu trade old news. And even more pressing is what's on deck Wednesday, says Woolfolk, noting that the Fed decision and first-quarter GDP report offer enough risk to make taking profit on the dollar's recent run a fairly easy decision.

As we’ve said before, forex trading is perilous. Indeed, as the North American Securities Administrators Association cautions: "Even when purchased through the most reputable dealer, forex investments are extremely risky."

The global currency market averages more than $3 trillion in turnover a day, according to the Bank for International Settlements, the central bank for the world's 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 these waters and you are 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, central bank interest rates, domestic and foreign policy statements, and, yes, swine flu -- if you thought day-trading stocks was tricky, the level of unpredictability here is of another order.

If you must dabble in forex, you're better off with an exchange-traded fund such as the Rydex CurrencyShares trusts. If you want to bet on the resurgence of the Mexican peso (the 12th-most-traded global currency) try the Rydex CurrencyShares Mexican Peso (FXM) ETF. True, it tumbled more than 4% Monday, but year to date it's still beating the broad market by a good three percentage points.