Investing in currency
A lot of people not involved in the forex market find it very fascinating and exotic. People often find it difficult to trade currencies because of the risks involved; still, the forex is the largest financial market in the world.
Investment in foreign currency assets usually represents a longterm investment where investors buy or sell currency pairs if they believe on the basis of technical and fundamental analysis that currency pair will rise or fall. Traders usually trade on a daily, weekly, or monthly level but investors invest in a couple of years in assets.
The forex market is primarily dominated by institutional investors and banks, though retail investors can also participate in it. In the forex market, the banks and the institutional investors are the market makers, which means they decide the price, on which retail investors trade later. By learning the basics of investing in foreign currency assets, and keeping yourself updated with the global news and trends, you can also fulfill your desire of trading currencies.
Basic Information on Investing in Currencies
Currencies of various nations are traded on the foreign exchange market, aka the forex market 24 hours a day for seven days a week. For some forex players, the forex market is useful to settle their cross-currency transactions, like for multinational companies, whereas for traders, it’s more about speculating on currencies to gain profit.
Currencies are traded across various markets across the globe, the most popular market among all is the London market. The currency market is operated between individual brokers, between two brokers, between banks, and between a broker and a bank. Though if you are a retail investor, this article will help you to understand how you can make an investment in foreign currency assets.
Currency markets are very liquid in nature, and thus it attracts traders on a large scale. As a currency trader, you are not liable to the margin limits levied by the Securities and Exchange Commission (SEC), and as a result, you can take on high leveraged trades as well. Investment in foreign currency assets can be done by trading in the forex market, trading ETFs (Exchange Traded Funds), investing in companies trading forex, and many more other ways.
Just like other financial markets, the currency market is also very volatile and invites higher risk as it is very sensitive to global events.
Invest in Foreign Currency
If you have the question – Can I invest in foreign currency, or how do I invest in euros; the first step you should take is to open a forex trading account. That you can do from anywhere in the world and can trade any currency at any time and from any market. However, there are certain differences when you compare the currency market to the United States stock market.
|Currencies are often bought and sold in pairs; you buy one currency against the other.||Stocks are traded individually; you buy or sell a stock and hope the market will move in your preferred direction.|
|The foreign currency market is not regulated, and there is nothing as such a central clearing house.||The US stock market is regulated and looked over by the Securities and Exchange Commission (SEC.)|
|There are no rules or uptick measures in place for opting a short position in currency markets.||In the stock market, you have to abide by the rules imposed by the SEC.|
|You do not face any upper limit for the position size you take.||You have to follow SEC guidelines for your position size.|
|In currency trading, dealers generate revenues from the bid-ask spread.||In stock trading, dealers generate revenues from charging a commission.|
How can You Invest in Foreign Currency?
If you also have questions in your mind like, “How do I invest in euros or how can I invest in currency?” here is your answer. By the stated methods, you can easily invest in foreign currencies.
1. Exchange currency in the exchange office
How do I invest in euros in a simple way? You may be surprised, but simply changing the currency at an authorized exchange is one type of investment. So if you have $50K and you think that EUR will go up, you exchange dollars for euros and after that you wait the whole year and make a profit.
The disadvantage of this currency exchange method is that your profit is very low because you do not have any kind of leverage. Your leverage is 1:1.
2. Certificate of Deposit (CD)
Various banks across the world offer Certificate of Deposit that lets you take advantage of various currencies. You earn interest in local currency rates of a specific nation via a CD; by having multiple CDs of different nations, you can leverage this instrument for your purpose of investment in foreign currencies. Many banks also offer forex accounts that work just like a money market account. You can easily transfer your money and gains of various currencies into your account.
Though, you should note that CDs get impacted by the exchange rate changes and fluctuations. At the maturity of a CD, you get more money than you invested initially. To protect yourself from bank side insolvency and currency market risk, you can take an instance from FDIC as well.
3. A Foreign Bond Fund
Many mutual funds invest in foreign government bonds and earn in that foreign currency. So, if you have taken a US based mutual fund that buys government bonds in Euro; you will earn higher interest when the Euro price increases. You will get more dollars in return when converted. A few of the mutual funds buying foreign government bonds are Aberdeen Global Income Fund, the Merk Hard Currency Fund, Templeton Global Bond Fund, etc.
4. Multinational Companies
Many a time, stockholders unintentionally take part in foreign investment as the companies they are holding stakes in are indulged in the foreign currency market because of their ownership and business practices in foreign nations. You can take examples of US companies like IBM, Walmart, McDonald’s, Apple, etc.
If that nation’s currency rate appreciates against the American dollar, you are likely to make a profit. The reason behind this is simple – the foreign currency income would have to be converted into the US dollar due to financial reporting requirements; the higher the value of that currency, the better the yield on the foreign exchange market.
5. Exchange-traded Funds (ETFs)
This instrument is just like the stock indexes, in which you can invest in forex without directly trading it in the forex market. Most brokerage accounts provide their customers with the option to trade in Exchange-traded funds (ETFs). A few such examples of ETFs are EUO, UUP, the ProShares UltraShort Euro, the Invesco DB US Dollar Index Bullish Fund, and more.
ETFs or Exchange-traded Funds are the easiest instruments to trade in forex; you don’t even have to be an expert here. All you have to do is to opt for an ETF which is managed in foreign currencies. Through ETFs, you can also trade in currency swaps and currency futures.
Here, you don’t have to take high leverage risk, as they are much similar to a stock index and can be bought from your forex broker. There are various brokerage houses in the market that give options for trading in ETFs. However, you should read all the important details related to the ETF you are likely to trade in, including the fees associated with it. The following are the most common ETFs for forex trading.
- CurrencyShares Australian Dollar Trust (FXA)
- CurrencyShares Swiss Franc Trust (FXF)
- CurrencyShares Canadian Dollar Trust (FXC)
- WisdomTree Dreyfus Chinese Yuan Strategy Fund (CYB)
- WisdomTree Dreyfus Emerging Currency Fund (CEW)
- ProShares UltraShort Yen (YCS)
- ProShares UltraShort Euro (EUO)
5. Exchange-traded notes (ETNs)
Exchange-traded notes (ETNs) are a little different compared to ETFs as they are more like corporate bonds than stock indexes. Though, they would give you an excellent opportunity to trade in foreign currencies. Some of the examples for ETNs are the iPath® GBP/USD Exchange Rate ETN, GBB, etc.
6. Investing Directly in Foreign Currency using brokers
If you have some experience in the forex market, this method would be easy for you. In a foreign exchange market, you can buy or sell your preferred currency pairs directly. The initial deposit required for the purpose of trading forex is as low as $50, where you also get margin up to 50 times, depending on your broker and the market you chose. You also should remember that the higher-margin will also give significant losses, just like significant profits.
It is suggested for you to look for a genuine broker after conducting your own research, as if this step goes wrong, you don’t even have to enter a trade to lose it. Go with your local or credible brokers, avoid foreign brokers, and those who claim higher returns in a short time; that is a big red flag.
An Example of how can investors invest in currency
Can you invest in a foreign currency using the broker? How do you invest in euros when you use a broker? In the first place, you open a trading account at some broker and then analyze currency pairs. If you believe that EUR will rise you need to find another currency that will go down. For example, the dollar economy is in the bad shape and technical analysis shows that USD can go down and you believe that EURUSD will rise. Then, you can BUY EURUSD for an example.
7. Hedging the Currency
This is not largely done by retail investors, and it is more of a risk management tool. If you want to protect your trades from opposite currency movements, you can opt for hedging the currency. Let’s take an example; you are trading in the euro against the dollar, but you are not sure about the euro rates in the future. So, you hedge the euro to protect your trade if the dollar strengthens in the future. The only backdrop of hedging is that it reduces the advantages of diversifying your portfolio.
Some of the popular currency hedge funds are as follows.
- WisdomTree Japan Hedged Equity Fund (DXJ)
- iShares Currency Hedged MSCI EAFE ETF (HEFA)
- WisdomTree Europe Hedged Equity Fund (HEDJ)
Rewards and Risks of Investing in Foreign Currency Assets
There are great benefits of investing in this market, but everything has two sides, and so does the forex market. Along with being the number one liquid market, there are risks that traders face. Let us look at how the forex market can balance your rewards and risk sides.
Rewards of investing in foreign currency
Diversification: As a trader, you have to learn the importance of diversification, as putting all your eggs in one basket can prove risky and is foolish as well. By choosing the forex investment, you chose to take off the risk associated with a single currency.
Liquidity: As stated, the forex market is highly liquid, with around $6 trillion of transactions occurring daily on an average.
Low cost: In the forex market, traders generally don’t have to pay the commission; instead, they pay the difference between the bid and ask price. It makes it cheaper compared to the equity market.
Flexible house: Unlike the stock market, the forex market remains open 24 hours a day for seven days as it operates from different parts of the world, so at any point in time, you would find an open forex market. As a result, traders have great flexibility to trade currencies.
Risk of Investing in Foreign Currency
High level of Volatility: The forex market is highly sensitive to global events and thus very volatile to trade in. The volatility here arises due to economic shifts, reports, interest rate changes by central banks, etc.
High Level of Leverage: Though here, the movements are tiny, the leverage is relatively very high. By using margin, investors can take advantage of taking large volume trades. It is not governed by any regulatory authority, and there is no uptick limit for the position size, giving many opportunities to traders.
As an investor, you must consider your trading strategy, capabilities, and risk management techniques to reduce the risk and gain sustainable profit. You should also take a leveraged position after considering how much you can afford.
So, What is the Conclusion?
You can easily trade in the forex market through these stated instruments; however, which one to choose depends on your experience, preferences, and risk appetite. If you want an easy solution, go for Exchange-traded funds as it has low leverage risk and is simple to get in. But if you are someone who wants to get benefits of higher leverage and want to feel this ocean, you can find investing directly suitable; just open a forex account, and you are already in.
The only thing you should remember is to keep a check on your risk to reward ratio and trading strategy as each method has its own pros and cons. Also, don’t involve your emotions in trading, as it would only sabotage your goals. Be a smart investor and educate yourself about the forex world before diving into it.
Currency market gets affected by various events occurring in the world and gives great opportunities to traders for making money. It is also a great tool for diversifying your investment portfolio.
As a currency trader, you should first make your trading strategy and decide your risk: reward ratio to jump into this fascinating field. With practice and experience, you will soon rule this realm.