What are the Risks of Foreign Stocks
Investors need to understand the additional risks they face from
investing in foreign stocks. As mentioned earlier, all companies
face business and financial risks, but additional risks pertain to
Currency fluctuations can adversely affect the value of stock
for U.S. investors. If the value of a foreign currency moves sharply
relative to the U.S. dollar, the value of the stock will either produce
spectacular gains or very large losses, even if the stock price
When buying foreign stocks, dollars are converted into the foreign
currency of the stock. When the stock is sold, the proceeds in
that currency are converted back into dollars. For example, the dollar
has recently fallen against the Euro, which has provided rather
large gains for U.S. investors in European stocks. However, if the
dollar strengthens against the Euro, these gains could be reversed.
Political risk is another important factor. The São Paulo stock
market in Brazil plunged over 50 percent during the early part of
1994 when the socialist presidential candidate showed an initial lead
in the polls. Thereafter, when the conservative candidate took the
lead, the Brazilian stock market soared. The Mexican Bolsa also was
badly shaken not only by the assassination of the leading presidential
candidate before the elections but also by a peasant uprising.
Many foreign countries tend to be less stable politically than
the United States, and any political upheavals in these countries
can erode foreign investments.
Another factor facing foreign investors is the information gap.
Foreign companies whose shares are not traded on the U.S. stock
exchanges do not have to follow U.S. accounting and reporting
standards. Not being familiar with the accounting and financial
standards of foreign companies can lead to inaccurate conclusions
about a company. In countries where companies are not strictly
regulated with regard to their adherence to accounting and financial
standards, there is the additional risk of fraud. Many Russian
investors lost their investments in the mutual fund called MMM
when it turned out to be a pyramid scheme. For many foreign companies,
information may be scarce, and even if there are reports
in the financial newspapers, interested investors could miss them
because they might not be feature news items.
Foreign companies whose stocks trade as American depository
receipts (ADRs), explained in the next section of this chapter, on the
U.S. exchanges are required to recast their financial statements using
U.S. accounting standards. This can explain some of the differences
in the reporting of accounting standards of foreign countries. When
Daimler Benz, the German auto company, initially requested a listing
on the U.S. stock exchange, it reported profits of $294 million in
Germany. When their financial statements were converted into U.S.
generally accepted accounting principles (GAAP), the profit was
reduced by $60 million (Glasgall and Lindorff, 1994, p. 102). With
less information available on foreign companies and different
accounting procedures, investment decision making on foreign
stocks becomes more complex than investing in American stocks.
Quotes on some of the thinly traded foreign stocks (and the pink
sheet ADRs that trade on the bulletin board) may be difficult to get,
which can make it difficult to buy and sell at predetermined prices.
However, this is changing as more of the computer online services go
global and as more investors become interested in foreign stocks.
Transaction costs of trading foreign stocks are much higher
than American traded stocks. In addition, because of the lower volume
of stocks traded, a large order by foreign standards, although
reasonable by American standards, could cause a trading imbalance.
This could result in larger price swings for the stock. This then poses
the risk of liquidity. If there are no takers for a large sell order of
stocks, then there could be increased bid and ask spreads in the
bidding for these stocks.
These risks need to be weighed against the advantages of
investing in foreign stocks. Despite the foreign-exchange risks over
the long term, foreign stocks can balance a portfolio in terms of
safety and can increase overall returns.
Categories in Trading Mistakes
Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor
Using too much Leverage
Determining the proper capital requirements for trading is a difficult task
Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure
Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader
Useful Advices to Beginning Trader
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