An image of a person looking at figures on a computer screen while seated in front of a window with the blinds drawn and the moon and stars visible serves as the illustration for the headline, which reads, “Pros & Cons: Investing in Foreign Currency,” with the text, “A big market with lots of buyers and sellers.” The opportunity to stray from the US dollar More time for trading: it operates five days a week, round the clock. Cons: high volatility and leverage. “
A lot of people believe that buying foreign currency sounds like an intriguing but dangerous venture. Banks and institutional investors control a substantial portion of the foreign exchange (or “Forex”) market. Everyone can now trade forex thanks to online brokerages and easily accessible margin accounts.
Understanding the advantages, hazards, and best methods for investing in foreign currency can be beneficial.
The Benefits and Risks of Foreign Currency Investment
Numerous considerations need to be taken into account before making the decision to invest in foreign currency. You should be aware of the numerous dangers that differentiate it from typical equity and bond markets because it is the biggest and most liquid market in the world. Notably, investing in foreign currency carries a higher risk of loss due to the high leverage (high loan level) employed in the transaction.
The following are the main advantages of investing in foreign currency:
- It is a huge and active market. The average daily trading volume on the foreign currency market exceeds $6 trillion.
- Through exchange-traded funds, the foreign exchange market gives investors an opportunity to diversify away from the possible dangers of trading currencies.
- Trading hours: The foreign currency market offers greater trading time than the majority of conventional equity, bond, or futures markets because it is open 24 hours a day, five days a week.
- Potentially low costs: The majority of trading in foreign exchange doesn’t require paying a commission, and the bid-ask gap is typically closer than with stocks.
The following are the main dangers of investing in foreign currency:
- Considerable leverage: Because the foreign exchange market fluctuates in extremely small steps, high leverage is required (through the use of margins). Investors are exposed to risk due to the incremental movements.
- High volatility: Economic reports, central bank actions, and other variables all contribute to the foreign currency market’s historically high levels of volatility.
- To help reduce these risks and boost long-term profits, you should carefully evaluate risk-management strategies. In order to minimize the hazards of directly trading in foreign currency via loans, you also need to have a lot of capital on hand.
Using ETFs for Indirect Investing
One of the simplest ways for those who aren’t currency specialists to invest in foreign currency is through exchange-traded funds (ETFs). These funds use instruments like swaps and futures contracts to buy and manage a portfolio of currencies on behalf of investors.
ETFs are advantageous to you since there is less risk associated with leverage. Instead of using a foreign currency broker, you can buy them via a typical stockbroker.
The two biggest companies offering exchange-traded funds (ETFs) that enable you to invest in foreign currencies are CurrencyShares and WisdomTree. ProShares and other businesses provide options to place leveraged bets for and against a number of well-known currencies. Before making an investment, you should thoroughly read the prospectus of an ETF to understand any fees and other crucial information.
Typical long exchange-traded funds (ETFs) that invest in foreign currencies include:
- Canadian Dollar Trust (FXC) via CurrencyShares
- Swiss Franc Trust via CurrencyShares (FXF)
- Australian Dollar Trust (FXA) via CurrencyShares
- Emerging Currency Fund (CEW) by WisdomTree
- Chinese Yuan Strategy Fund (CYB)15 from WisdomTree
A security you own can be sold, or you can borrow one to sell and then buy it back at a discount (called a “short”). To short an ETF and wager against a foreign currency, consider:
- Euro UltraShort ProShares (EUO)16
- YCS17 ProShares UltraShort Yen
- Direct Foreign Currency Investment
Through a foreign exchange brokerage, you can immediately purchase and sell individual currencies on margin (with borrowed funds). Investors can purchase currencies with a 50:1 margin with as little as a $50 initial payment. Remember that utilizing margin increases leverage, which increases volatility and raises the possibility of higher losses.
Spend some time researching and choosing a top-notch forex broker. The rules governing the FX market are less strict than those governing the American equity markets. Make sure to stay away from overseas brokers who are not subject to international regulation. 1920
To guard against asset losses caused by currency fluctuations, certain investors may utilize currency hedges (risk-mitigation methods). To hedge against any decline in the price of the euro, they might, for instance, short the euro if they purchase stock in European firms. The drawback of currency hedging is that it eliminates some of the advantages of diversification.
The following are common currency-hedged funds:
- Hedged equity fund managed by WisdomTree (HEDJ)21
- Japan Hedged Equity Fund (DXJ) by WisdomTree
- Currency Hedged MSCI EAFE ETF (HEFA) by iShares
ETFs are a possibility if you’re seeking a simple way to invest in foreign currencies. These funds have lower risks associated with leverage and are straightforward to trade using conventional stock brokers.
By opening a foreign exchange brokerage account and buying the currencies on leverage directly, you can also gain more direct exposure to foreign currency. Before making investment decisions, you should carefully consider these considerations as each strategy has its own risks and rewards.
Questions and Answers (FAQs)
Will banks convert my foreign currency?
Banks may exchange foreign currency for you, but they are unlikely to provide leverage unless they also provide foreign exchange trading accounts. To put it another way, while you can exchange cash for foreign currency at a bank, it’s unlikely that you will be able to invest with the leverage and pricing control necessary to be successful as a trader or investor.
How do foreign currency rates work?
The price you may acquire in one currency for another is known as the exchange rate. The exchange rate is 1.35 if one British pound (GBP) can buy you $1.35 in U.S. dollars. These currency rates normally include the spread and any additional conversion costs levied by the exchange. Instead of saying “rates,” traders will occasionally say “pairs,” as in “The GBP/USD pairing is 1.35.”