Why foreign-exchange trading is hazardous.

If you watch financial news on cable television these days, you've seen the pitch for foreign-exchange trading, or forex. Investors are being bombarded with messages like "learn to retire in 10 years or less," "become financially free," or my personal favorite: "The quickest, easiest way to turn a paltry $500 investment into a $522,053 fortune with forex trading."

Perhaps it's the fact that the stock market seems to be bottomless or that commodities are in a slump (aside from gold, the subject of other infomercials). Day traders are being tempted with online courses, Web seminars, and countless e-books purporting to explain the secrets of making a killing trading currencies. The question: Is this really a once-in-a-lifetime opportunity, as the advertisements suggest, or a remarkably quick way to separate investors from their hard-earned cash?

For the uninitiated, forex trading works like this: Traders set up an online account at one of the 39 foreign-currency dealers approved by the government. The investor then bets on the movement of currency pairs such as the euro and dollar or Swiss franc and Japanese yen. While there is often no commission on a sale, the broker sets the price for buying and selling each currency—there is no central forex exchange—and collects the generous "spread" between the two. What makes the trading really attractive to many speculators is the leverage being offered: Day traders can deploy 100-to-1 and sometimes even 200-to-1 leverage, so a $1,000 investment can buy $200,000 worth of foreign currency. Isn't this beginning to sound a little like an excursion to the Vegas roulette tables?

Proponents of foreign-currency trading, and there are many of them on the Web, insist the risk can be lowered if only you have the right system—either by studying news reports about economic developments in various countries whose currencies are traded or by using technical analysis to chart past trends, suggesting that the movement of a currency can be determined by examining previous gyrations. Of course, the forex bulls want to sell you that advice. And tens of thousands of investors have been bitten.

Whether any of these systems work is open to debate, but Alan Greenspan, the former chairman of the Federal Reserve, who presumably had a lot of economic data at his disposal, has expressed his doubts in an uncharacteristically clear way. "Despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin," he told a conference in Frankfurt. "I am aware that, of the thousands who try, some are quite successful. So are winners of coin-tossing contests."

As Greenspan went on to suggest, the real key to making money in forex is to be the dealer rather than the day trader and collecting those nice spreads. As a recent article in the Financial Times noted, low volatility in exchange markets creates a bear market for the foreign-exchange industry, while high volatility, such as now exists, is considered a bull market. So, for example, the spreads offered on the pound versus the dollar are now five times higher than before the collapse of Lehman Bros. last September. The spreads retail investors pay fluctuate from Web site to Web site but are usually between $10 and $40 for a $10,000 investment.