Forex Blog: Currency Trading News & Analysis.

December 18th 2007

Trading Forex Becomes Less Profitable

The return a hedge fund delivers is separated into alpha and beta; accordingly, the goal of of a good hedge fun manager is to deliver as much alpha as possible, whereby alphas is measured by the return generated in excess of beta, what is returned "naturally" by the market.  In the case of forex, the beta is effectively zero, since one currency’s gain is automatically another currency’s loss.  Thus, any and all return generated by forex investors is officially recorded as alpha.  Historically, forex was a bonanza for hedge fund managers that speculated exclusively on currencies, who averaged annualized returns of 12%, controlling for differences in trading strategies. 

That return has steadily dwindled, and in fact, the average professional forex trader lost 2.6% in 2006.  The reasoning should be self-evident: increased competition.  From the perspective of daily trading volume, participation in the forex market has tripled since 2001.  Arbitrage (buying in one market and selling into another) has steadily eroded returns to the extent that one online forex brokerage now quotes the bid/ask spread to five decimal places!  Fortunately, the evaporation of profits should drive many hedge funds out of forex in search of other investing opportunities, creating new opportunities in forex.  The Financial Times reports:

Volatility was now back to historic norms, aiding managers. "The last three years have been really quite disappointing for the industry and it needs to produce some gains in the next couple of years to justify its existence."

Read More: Dollar slide ‘hit currency managers’

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Posted by Adam Kritzer | in Investing & Trading | No Comments »

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