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Cash In on the Recession

moneyWeakDollarWorkout_article01.jpgBack in July 2005, Erik Herzfeld had a hunch. The currency trader, 32 years old at the time, was well aware that China had been inundating the American marketplace with increasing amounts of toys, computer equipment, and clothing for years. Since this was long before people realized Chinese goods were constructed largely from arsenic-soaked lead, Americans were buying the hell out of the low-priced products, supercharging China’s economy with billions in U.S. capital and making its currency, the renminbi, increasingly valuable. So, if Herz­feld could swap his ever-weakening American cash for Chinese currency before it soared in value—and then trade it back—he could make a fortune overnight.

There was just one problem. For two dec­ades, the Chinese government had prevented the value of the renminbi, from moving at all. Logic told Herzfeld that buying the currency would be a waste of time and money. But he was a good trader, so he did his homework.

Via the Bloomberg message system, an online service that allows users to track e-communications between financial institutions, Herzfeld noticed increased activity by the People’s Bank of China and the Chinese State Administration of Foreign Exchange. “They started working very late,” he says. “I knew something was brewing.” Herzfeld leveraged big, essential­ly taking out a high-risk loan, and used $80,000 to speculate on $200 million in renminbi. Six days later Beijing announced that the Chinese had let the renminbi rise to its true market value—2.2 percent higher than when Herzfeld bought it. In other words, his $80,000 investment had just netted him $5 million.

“You don’t need to go to a fancy school to trade currencies,” he explains. “No one is right 90 percent of the time. But you can make money—a lot of it—if you’re right 60 percent of the time.”


The Iron Is Hot
Since the first opening bell of 2008, the stock market has been plagued by darkening economic forecasts. Combine that with the fact that the dollar is in the toilet—last year alone, the greenback’s value fell an average of 10 percent compared to other world currencies—and it’s easy to see why skittish investors are bringing their business to the currency market. Right now, more and more amateurs are exchanging weak U.S. dollars for cash with more muscle.

While currency trading used to be the sole domain of big banks and credit institutions, over the past few years retail brokerage houses have set up shops for any would-be trader with an Internet connection and a healthy checking account. It’s the Wild West of investing—all online trades are anonymous, and the market is open for business 24/7. The result is a market that’s exploding with activity. In 2003, Foreign Exchange (FOREX) brokers held $170 million in customer funds; by 2007, that figure had grown to more than $1 billion. And since 2000, the number of individual traders registered with one major online currency trading firm, FXCM.com, has ballooned from 100 to 100,000.

But it’s far from a sure thing. “I learned about it three years ago from a client,” says George
Bacardi, a 39-year-old CPA who earns about $85,000 a year trading currency on the side. “I gave it a shot, lost all my money, and was still hooked. My best day, I’ve made $7,000; on my worst, I probably lost as much as 10 grand.”


Mastering the Market
There are two ways to make money. The first is just like Herzfeld’s China play: You buy a currency you think will increase in value, then sell it back when it’s worth more than the U.S. dollars that you bought it with. But you can also earn a fortune by betting a currency will tank. Financier George Soros speculated back in 1992 that the British pound was about to take a plunge, and banked $1.1 billion in one day’s time when he turned out to be right.

Of course, there’s a catch. These markets move violently, and if the currency you sold goes up instead of down, you pay the difference. To avoid disaster, you must be a financial news junkie. Read The Economist, check international newspaper headlines online, and sign up for a currency trading newsletter. “An FX trader doesn’t sleep,” says Robert Paulson, 35, founder of currency trading firm First Lenox. “You may rest your eyes, but you don’t sleep.”

Lee Martin, 45-year-old owner of a countertop installation company in Georgia, has been trading for 10 years and admits the lifestyle can be hectic. “London gets going at 2 a.m., so I’ll get up at 1 or 2 and see what’s happening. Then I’ll take a catnap and check again at 4. The Far East is active from about 7 p.m. to midnight, so you want to pay attention then. From 12 to 1:30 you can take a break.” But there is a payoff to the sleepless nights. Martin earns about $30,000 a year on top of his regular income.

What sort of information should you be looking for? Omens that an economy is getting worse—widespread unemployment, evil dictators, disasters; all can drag a currency’s value down. Positive economic indicators—optimistic consumers, robust spending, low inflation—indicate a currency will go up.

“Prices form classical patterns,” says Marc Prosser, chief marketing officer at FXCM. “Things that are rising continue rising, and things that are falling continue falling.” Sites like Prosser’s—Forex.com, FXStreet.com, and HotspotFX.com are three others—provide users with performance charts of dozens of currencies. They’ll show a currency’s “support level,” the price at which it stops falling and begins to rise; and its “resistance level,” the ceiling at which it will stop rising. Also take note of oscillators, which measure the speed of a trend. “You want to buy when the momentum is strong and in your favor,” Prosser explains. “When the trend gets slower, it’s losing steam.”Make Your Move
You’ll need to know three prices before placing your order. First, the price at which you’ll sell. Look at the charts. How high or low will the price move? Will any economic indicators be released to interrupt the pattern? Watch closely, and remember history. “See how prices reacted to news in the past,” Herzfeld suggests. “Then use that information to predict the future. A good trader has a great memory.”

Second, enter your buy order. You don’t have to pay the market price; instead, instruct the site or broker you’re using to execute the trade at whatever price level you like. Will the price go lower? Check the charts. If it seems temporarily inflated, put your order in at the price where you think it’ll settle.

Finally, protect your downside with a “Stop Loss.” If the currency moves in the wrong direction, make sure the order system automat­ically dumps the trade when you’re down somewhere between two percent and five percent. Planning properly for all three variables should give you the sense of security you need in order to brave such a volatile market. “Hard-code your game plan and wait for it to happen,” Herz­feld says. “Don’t say, ‘Oh, my God! I just talked to my friend, and maybe I’m wrong.’ Just sit back and say, ‘I’m right.’¿”


The Big Money
Most amateur traders agree that a ton of cash isn’t required to join the game. “You don’t have to have big five- and six-figure accounts,” says Martin. “You’ll make more money if you do, but you can get into this thing for $1,000.” If you have more money to play with, however, and you feel confident enough to take on massive risk in order to hunt huge gains, there is one more weapon at your disposal: leverage. By borrowing from a broker, you can control $100 worth of currency for every $1 you actually have. It’s the tactic that allowed Herzfeld to gamble with $80,000—and rake in $5 million in profits. With the help of leveraging, any bozo can immediately become a player. And players can just as easily be ruined.

Almost any expert will tell you that leverag­ing yourself 100-to-one is financial suicide. Think about it: At that ratio, if you speculate with $10,000 and max out, you’re suddenly trading with $1 million. But if the currency price moves down just one percent—prices fluctuate like that continuously—your broker will immediately take what you owe from your account. In other words, you could be dead within hours. “You want to make sure you can recover from a reasonable string of bad trades,” Prosser says. “Leveraging 20-to-one is more than enough.”

Remember that leveraging is borrowing—and that means paying interest. If neither currency moves at all, you could be out those payments. So be smart. “There are no rules in this game,” Herzfeld says. “You can get kicked in the nuts, punched, horse-collared—and no one is there to call a foul. The big boys come to play. And lots of them win big.”