Life insurance and collectibles are the two prohibited investments in an IRA. There are other well-known opportunities allowed within IRA requirements, such as purchasing real estate, holding secured loans, and forming LLCs to make your portfolio more diverse. Foreign exchange trading (forex) is yet another option that falls within the guidelines and is gaining popularity among individual investors. This article explains what foreign exchange trading is, why people like it, and how the process works within a self-directed IRA.
What is foreign exchange trading?
The foreign exchange market was initially started to facilitate international business, making trade easier between one country and another. An entity (i.e., bank, business, or country) that uses one currency can more readily do business with one that uses another. For example, the exchange market allows a firm in the United States to sell goods to a Japanese firm. The Japanese firm can use their yen to buy dollars to pay the American firm or, the American firm can accept payment in yen and then convert the payment to U. S. dollars.
Investors profit in the foreign currency exchange market by taking advantage of price fluctuations, much like the stock market. However, currency pairs are traded instead of company stocks. Using the above example, the dollar and yen consist of a currency pair. The amount of yen to purchase a dollar moves up and down constantly based on many external market pressures, such as supply and demand, economic policy, and world events. Investors may profit by successfully positioning themselves in a long or short purchase.
A “long” position is where the investor intends to buy low and sell high. The investor enters the transaction if he or she thinks the dollar is undervalued and its value will increase. A “short” position earns profit in the opposite fashion. The investor sells the currency when he or she believes it is overvalued and buy it back when the value decreases.
Why is forex popular?
The foreign exchange market is the largest financial market in the world and has become popular with individual investors for several reasons: It is liquid, easier to control, and allows an investor to start with a small account value. Liquidity refers to the ability of a position to be converted from a holding and back to cash. As people adjust from an atmosphere of buy and hold investing to one of active trading, this extreme liquidity enables them to enter and exit trades quickly.
Another advantage is that foreign exchange markets are open 24 hours a day, from Sunday evening through Friday afternoon. This wide range of hours enables trillions of dollars to be traded daily and gives an investor a nearly unlimited access to the market, allowing more control than traditional equities markets.
The Internet has made this platform more readily available to individuals as opposed to just banks and large corporations. However, although there are high profit potentials, there come substantial risks as well.
How does forex trading work in a self-directed IRA?
Well, the process is actually quite simple. A person opens an Advanta self-directed IRA, funds the account, and then instructs Advanta IRA to establish an account with a foreign exchange firm in the name of the IRA. The beneficiary of the IRA then trades with the account. All gains are tax deferred or tax free depending on the account.
This is a great option for people who are interested in self-directed IRAs, but aren’t sure what to do with a small account size. They may not have $100,000 for that rental property or $50,000 for that secured loan investment. Or they may just have a tidy sum left over due to positive returns on another self-directed investment. Nano, micro, mini, and standard accounts can be started with reasonable amounts of cash. Please see your desired broker for more information.
Remember, there is risk involved in trading foreign currencies. There are many outside factors that cause all markets to fluctuate. Always perform due diligence and measure your own risk aversion before getting started.
For questions regarding this article, please contact Scott Maurer, director of business development for Advanta IRA. He can be reached by calling 800-425-0653, or by emailing SMaurer(at)AdvantaIRAGroup(dot)com.