Places You Don't Belong

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Investors have a lot of choices: stocks, bonds, gold, foreign exchange and many derivatives of these such as preferred stocks, convertible bonds, etc.  Some of them are excellent for individuals.  Some of them are  regions loaded with land mines, welcoming fresh, naive money, then exploding without warning.  Here are some places individuals just don't belong.

Foreign exchange.  This is a market where major multinational corporations find hedges for their many currencies.  They buy and sell in the multi-millions of dollars (or yen or euros).  They have a purpose: to limit the company's exposure to currency fluctuations.  In other words, if a company is headquartered in the U.S. and sells products in Europe, it might want to sell the euro or buy a put on it so that when sales happen, the dollar exchange ratio for the euro is fixed.  That way the company knows exactly how many dollars it will receive rather than take the risk of having the euro move up or down and thus give the company fewer (or more) dollars when it converts those euros to dollars.

Foreign governments are also actively trading this market as they hold assets (including lots of Treasury bills, notes and bonds) that need to be hedged so that the dollars they receive are worth something when those dollars are converted into the government's own currency.  These transactions are done in the billions of dollars.

Then there's me and you.  Feeling much like the ant playing on the elephant path, we may be able to enjoy some time buying and selling but ultimately this market moves too quickly and by large particpants for us to have any clue as to what is going on.  Our money only adds liquidity to the market, it doesn't have any effect on it. 

Of course there are ways to be involved in currencies: buy them outright and hold them.  Buy mutual funds that specialize in foreign companies.  Or buy funds that specialize in one country.  Or, if you have the extreme discipline and must partake, then use puts and calls to limit your exposure for loss.

Another institutional market: preferred stock.  While these give great yields, sometimes, they are actually constructed for institutional holders, mostly other companies.  That's because they have a favorable tax treatment for companies that own them.

Furthermore, it's almost impossible to find good research on preferred stocks.  While there is some, it's meant for institutions that can buy millions of dollars worth of preferreds at a time and can use the major Wall Street firms to execute trades.  Individuals are lured by the strong yields, but they have no idea of what's really going on in the preferred markets because they can't get informaton on it. 

If you love the yields, buy a mutual fund that specializes in preferred stocks.  There are several of them.  They have professional management that gets the research and has the expertise to fully exploit these high yielding stocks.

Another area: gold, silver, oil, all commodities.  These are, again, for large companies and countries that use the exchanges to hedge against actual holdings or usage.  They move quickly (see last week's crash in oil and gold as examples).  They can be influenced by political, currency, natural disasters, and numerous other events that have nothing to do with supply and demand.  They are where the biggest elephants play.

Again, if you want to be in these areas, buy individual stocks that drill for oil, or use gold and have a professional expertise to manage the vagaries of these markets.  Or buy mutual funds that focus on gold or silver or precious metals or oil.  There are lots of them.  Once again, if you have to have the thrill of the chase and want to be in these markets directly, use options to limit your losses and have extreme discipline.

With all of these markets, it is possible to be involved directly, but the problem is that most traders have the human frailty of staying with a losing position, hoping it comes back to break even or maybe a profit.  Most of us lose everything hanging on to that hope.  If you have the discipline to use stop losses, you can be in these markets.  But very few have that extreme discipline, day after day, to succeed.

One more thing to remember: information on these markets is like rain that falls on a mountain.  It hits the top first, then trickles down.  The information on all of these is first told to institutional investors who immediately make a buy or sell decision and can move markets.  You and I are at the bottom of the mountain, wondering when the water will arrive, if it ever does.  Sometimes we never get it.

Good luck to any one who wants to be in these markets.  They'll need it.  Because these are places individuals just don't belong.

- Ted Allrich
May 10, 2011



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.




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