Long-term investing in the forex is a relative term. If short-term (swing) trades last from hours to days and midterm positions last from a few weeks to a few months, then long-term investments may last a year or more. Clearly this isn't the same as long-term investing in the equities or bond markets, but the forces at play are not the same either. Although many forex investors start trading using short-term strategies, it makes sense to learn to apply longer-term investing techniques as well to smooth your equity curve.

The forex provides some significant advantages to long-term investors that cannot be matched in most markets accessible to the retail investor. Long-term investing changes the trading process in profound ways. Here are a few of the advantages provided by long-term investing. You will notice that some of these are actually disadvantages of short-term investing. I have also put a few examples in this study for illustration purposes.

The forces that drive exchange rates in the long term are not complicated and can be understood readily. In the long term, most economic forces can be diluted down to their affects on yields. Ultimately, most of the major currencies will be driven by their relative yields. A great way to quantify that is with the primary interest rate, usually set by the domestic central bank.

Obviously risk still exists but since long-term analysis is not as time sensitive, it is a little easier to make informed decisions without as much pressure from price slippage. Results from short-term trading can be impacted significantly with slippage of 10–40 pips. Long-term investors are often targeting 1,000 pips or more in a single trade, which gives you a lot more flexibility because regular slippage accounts for less of the total trade potential.

Aside from slippage, forex traders need to be very careful about the spread between the bid and ask prices. Forex dealers love to tout the fact that most of them do not charge a commission for trades. This is a little misleading since the dealer is the counterparty to each trade. Because they are the other side to each trade, they are actually rolling any commission they might charge into the spread. If you look at this as a percentage of the potential gain in a short-term trade, the actual cost is very high. For example, during market hours, the spread on exchange-traded currency futures are often less than a pip.

Because the spread is a much smaller percentage of the profit target of a long-term investor, it loses much of its sting. Spreads in the overthecounter forex market continue to tighten, but this will always be more of an advantage for the longterm investor compared to the short-term trader. One of the most significant advantages of long-term trading is the impact of yield differences between currencies. For quite a few years, the Bank of Japan has kept interest rates extremely low. For a long time it has been close to 0 percent. This has occurred while other countries have maintained very high interest rates. Carry traders take advantage of this differential by selling the Japanese yen and buying a higher yielding currency like the British pound. That is actually a very simple transaction and can be accomplished by buying the GBP/JPY currency pair.

The effects of these differentials can be seen in your own trading when you are paid a premium each day at roll over when you are long this currency pair. Conversely, you can be charged when you are short this same pair. Similar relationships exist between other currency pairs and have been a great way to take advantage of the currency market for some time. Many traders relying on this method of trading will reevaluate their trades infrequently. It is still critical to properly diversify your portfolio from shocks and shifts in interest rates, but knowing about this relationship and using it in your own long-term opportunities can put the odds a little more in your favor. Additionally, the daily interest rate payment that longterm traders earn can be a great source of income to offset potential losses.

The GBP/JPY monthly chart showing a possible gain of 6,204 pips in four years.

Source – FXSoI

I recently conducted an analysis of the four largest carry trade currency pairs available from OTC dealers and purposefully excluded the British pound or the Japanese yen. These currencies included the Thai baht, Mexican peso, Australian dollar and the U.S. dollar. On a weighted basis and without using any leverage, they returned 12 percent, as a basket of currencies, during the past 12 months. Using some judicious leverage and making adjustments when necessary is a common strategy amongst many hedge funds.

There are a few disadvantages to long-term trading in the forex market. Because the trade is intended to last longer, draw downs in your account can be much deeper than they would be for a shorter-term trader. That means that managing your leverage is critical. It is also true that there may be longer periods of losses as the market trends against what would normally be expected. As with any methodology, the anticipated costs or losses should be offset with the possible gains, but setting your expectations is key.

John Jagerson is a writer about and active trader in the Forex. His book, Profiting With Forex, published by McGraw Hill, is available nationwide. He can also be seen daily on http://www.profitingwithforex.com.