You can’t predict when or if a currency will come down. So don’t base your buying decisions on currency forecasts

An interesting and thought-provoking question recently came in from a member of our Inner Circle.

The member asked,

“Pat, I know you recommend diversification among individual stocks and stock groups, and between the U.S. and Canadian markets. But right now, the U.S. dollar is way above the Canadian dollar in foreign exchange markets—higher than I’ve ever seen it. Shouldn’t we hold off on buying more U.S. stocks? I’d like to wait till the U.S. dollar goes back down to where it was a few years ago.”

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Generally speaking, this is not a good idea. To start, the foreign exchange value of a U.S. dollar is one step removed from the U.S. dollar value of U.S. stocks. The U.S. dollar and U.S. stocks don’t move up and down together, like a bunch of people in an elevator. Some U.S. stocks move in tune with the U.S. dollar for short or long periods, then abruptly change course.

The difference is easier to see if you compare it to the difference between buying stocks and buying cars.

You can’t negotiate a better price for a stock

Investors who “bargain shop” for bargain stocks explain that they just want to buy stocks the way a smart consumer buys a car. But they overlook one key difference. Car prices do vary from dealership to dealership. Some car buyers do pay less than others. They may have better bargaining skills, a better knowledge of cars, or just more time to spend shopping around.

However, the stock market is more efficient than the car market, as an economist would put it. You can’t negotiate a better price for a stock. To pay less for a stock, you have to wait for its price to come down.

The bargain-hunters approach can backfire. Stocks that seem attractive but too high can keep going higher for months, or even years. When they do start to drop, it may be due to a hidden flaw that has just appeared and begun to hurt business.

You can’t predict when or if a currency will come down to where you want to buy it. For that matter, you can’t predict if the currency and stock will move in tandem, or abruptly diverge.

Before you buy stocks based on any indicator, it’s best to see how it did in the past. Most market indicators are based on a short but carefully chosen slice of market history. If you look at how the indicator worked over a longer, randomly chosen slice of market history, you’ll probably be less impressed. The rule is, sometimes indicators work and sometimes they don’t.

You need to look closer

Before you base investment decisions on casual observations, it’s best to dig into recorded data. One way to start is by looking at a chart. Here’s one from a great online source of statistical data, TradingEconomics.com:

TradingEconomics.com

This Trading Economics chart goes back half a century, to the 1970s. That was a tumultuous decade, a little like today’s. President Nixon resigned under threat of impeachment, interest rates and real estate prices hit staggering levels, the U.S. military made an embarrassing retreat from a developing country, and a Canadian province began seriously threatening to secede from Canada.

For much of that decade, despite the turmoil, the U.S. and Canadian dollars stayed within a few cents of each other—near “par” as currency traders refer to it.

As you can see on the chart, subsequent years were kinder to the foreign exchange value of the U.S. dollar. It rose 60% (in relation to the Canadian dollar) over the next few decades, reaching a high near $1.60 Canadian in the spring of 2002.

“Waiting for a drop to reasonable levels” would have been a frustrating strategy back then.

The U.S. dollar did briefly get back down below par, a couple of times: It came down close to $0.95 Canadian in 2007 and again in 2011. Four years later, in 2016, it got up to $1.40 Canadian. In the seven years since, you might say the U.S. dollar has stabilized. It pretty much stayed in a range between the $1.40 peak that it hit several times and lows that averaged out at around $1.23.

Why did it move that way? Millions of foreign exchange market players made billions of trades over those years. Virtually every one had a reason, good or bad, for buying one currency and selling another. Their collective differences of opinion created the random movements that you see on the chart.

The ‘easy way’ only works once in a while

Individual traders and speculators carry out a tiny proportion of foreign exchange trades. Few of them make money in the long run. Most give up on foreign-exchange trading when they’ve lost as much money as they care to lose.

Most foreign-exchange trading takes place for business reasons. Banks (commercial and central), investment companies and multi-national businesses trade to fix their costs or take advantage of what they see as upcoming price changes. They can still lose money, just like amateurs. But they mostly make money because they are set up to approach foreign exchange trading as a business, rather than as a sideline or hobby.

Foreign exchange markets are highly efficient, as an economist would say. Nobody can consistently predict moves in any efficient market. However, market efficiency gives the banks, investment businesses and other large-scale, well-financed operators an advantage over individuals.

These big organizations carry out extensive research about the multitude of facts that influence foreign-exchange trends, and they trade much more actively than individuals.

This lets them cut their costs, suffer less damage from the inevitable losing trades, and wring more profits out of their successes.

Aim for a successful investing career, not just an occasional win

Deciding what to buy is more rewarding than when to buy; it just takes longer to pay off. That’s why diversification is more profitable in the long run, and less frustrating than market timing.

The surest way to make money in stocks is to start out by following our three Successful Investor rules for sound investing. They are the foundation of our Successful Investor system.

Here are our three key principles:

1. Invest mainly in well-established companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

Have you ever waited for a stock to drop, only to have it continue to climb and wish you jumped on sooner?