How to Invest in Foreign Currencies

Investing in foreign currencies from home

Benefits and Risks

There are many factors to consider before making a decision to invest in foreign currencies. It is the largest and most liquid market in the world, so you should be aware of the many risks that set it apart from the regular stock and bond markets. For example, the high leverage used when investing in foreign currencies can lead to increased volatility and heightened risk.

The main benefits of investing in foreign currencies include:

• A large market and liquidity: The daily trading volume in the foreign exchange market exceeds 6 trillion dollars.
• Diversification: The foreign exchange market provides investors with a means to diversify away from the potential risks of trading currencies through exchange-traded funds (ETFs).
• Trading hours: The foreign exchange market operates 24 hours a day, five days a week, providing more time for trading compared to most stock, bond, and traditional futures markets.
• Potentially low costs: Most foreign currency trading does not involve commission payments, and the bid-ask spreads are narrower than for stocks.

The main risks of investing in foreign currencies include:

• High leverage: The foreign exchange market moves in very small increments, making high leverage (through margin use) a necessity. These gradual movements also pose risks for investors.
• High volatility: The foreign exchange market is characterized by high levels of volatility due to economic reports, central bank interventions, and other factors.

You should carefully consider risk management techniques to help mitigate these risks and enhance long-term returns. Additionally, you need to have a substantial capital on hand to avoid the risks of using debt to trade directly on foreign capital.

Indirect Investment Using Exchange-Traded Funds (ETFs)

Exchange-Traded Funds (ETFs) are one of the easiest ways for novice currency investors to invest in foreign currencies. These funds buy and manage a portfolio of currencies on behalf of investors using instruments such as swaps and futures contracts.

You can benefit from ETFs as they do not carry the same risks of leverage. You can also purchase them through a traditional stock broker rather than a foreign exchange broker.

CurrencyShares and WisdomTree are the largest providers of ETFs designed to help you invest in foreign currencies. Meanwhile, companies like ProShares offer ways to make high-risk bets both for and against a variety of popular currencies. You should read the ETF brochure carefully before investing to understand any fees and other important information.

Some common long ETFs (buy to hold and sell later) that invest in foreign currencies include:

• CurrencyShares Canadian Dollar Trust (FXC)
• CurrencyShares Swiss Franc Trust (FXF)
• CurrencyShares Australian Dollar Trust (FXA)
• WisdomTree Dreyfus Emerging Currency Fund (CEW)
• WisdomTree Dreyfus Chinese Yuan Strategy Fund (CYB)

You can sell the security you own, or borrow a security to sell it and buy it back at a lower price (known as “shorting”). Some short ETFs to bet against foreign currencies are:

• ProShares UltraShort Euro (EUO)
• ProShares UltraShort Yen (YCS)

Direct Investment in Foreign Currencies

You can buy and sell individual currencies directly using margin (borrowed funds) through a foreign exchange broker. With an initial deposit of just $50, investors can buy currencies with margin levels of up to 50 to 1. Remember that greater leverage obtained through margin also translates into increased volatility and higher loss risks.

Review and choose a quality forex broker. The forex market does not have the strict regulations that exist in the U.S. stock markets. Be sure to avoid unregulated foreign forex brokers.

Hedging

Currencies

Some investors may use currency hedging (risk mitigation strategies) to protect their assets from losses caused by currency movements. For example, if they purchase shares in European companies, they may also sell euros against U.S. dollars to safeguard against any downward price movement in the euro. The downside is that currency hedging removes some of the benefits of diversification.

Notable hedge funds include:

• WisdomTree Europe Hedged Equity Fund (HEDJ)
• WisdomTree Japan Hedged Equity Fund (DXJ)
• iShares Currency Hedged MSCI EAFE ETF (HEFA)

Conclusion

If you’re looking for an easy way to invest in foreign currencies, you may want to consider exchange-traded funds (ETFs). These funds are easy to trade with traditional stock brokers and carry lower risks related to leverage.

You can also gain more direct exposure to foreign currencies by opening a foreign exchange brokerage account and purchasing currencies directly using margin. Each approach has its own risks and rewards, and you should carefully consider these factors before making investment decisions.

Frequently Asked Questions (FAQs)

Do banks exchange foreign currencies for me?

Banks may exchange foreign currencies for you, but unless you are dealing with a bank that also offers foreign currency trading accounts, they are unlikely to provide leverage. In other words, you can exchange cash for foreign currencies at the bank, but you probably won’t be able to invest with the price control and leverage necessary to make a profit as a trader or investor.

What is the foreign exchange rate?

The exchange rate is the price at which you can obtain one currency against another. If one British pound (GBP) can buy $1.35, then the exchange rate is 1.35. These rates usually include the foreign currency margin and any additional fees the exchange will charge for the conversion. Sometimes traders refer to these transactions as “pairs” rather than “rates,” so they might say instead, “the GBP/USD pair is 1.35.”

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Sources:

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

Bank for International Settlements. “Triennial Central Bank Survey: Foreign Exchange Turnover in April 2019,” pages 7 and 18.

Bank for International Settlements. “Information Flows in Foreign Exchange Markets: An Analysis of Customer Foreign Exchange Transactions,” page 1.

Bank for International Settlements. “Triennial Central Bank Survey: Foreign Exchange Turnover in April 2019,” page 3.

Library of Congress. “Foreign Exchange Market.”

OANDA. “Trading Basics.”

National Futures Association. “Forex Trading – What Investors Need to Know,” page 14.

ASIC’s MoneySmart. “Foreign Exchange Trading.”

Washington State Department of Financial Institutions. “Investing in Exchange-Traded Funds (ETFs).”

FINRA. “Regulatory Notice 08-66: FINRA Addresses Retail Foreign Exchange Activities.”

U.S. Securities and Exchange Commission. “Investor Bulletin: Exchange-Traded Funds (ETFs).”

New York Stock Exchange. “Invesco CCY SHS CDN DLR TR CDN DLR SHS ETF FXC.”

New York Stock Exchange. “Invesco CCY SHS SWISS FRANC TR SWISS FRANC SHS ETF FXF.”

New York Stock Exchange. “Investco CCY SHS AUSTRALIAN DLR TR AUSTRALIAN DOLLAR SHS ETF FXA.”

WisdomTree. “Emerging Currency Strategy Fund.”

WisdomTree. “Chinese Yuan Strategy Fund.”

ProShares. “EUO UltraShort Euro.”

ProShares. “YCS UltraShort Yen.”

Cornell University Law School Legal Information Institute. “12 CFR § 48.9 – Margin Requirements.”

Authority

U.S. Securities and Exchange Commission. “International Investment”.

U.S. Securities and Exchange Commission. “Forex – Foreign Currency Transactions”.

WisdomTree. “Europe Hedged Equity Fund”.

WisdomTree. “Japan Hedged Equity Fund”.

iShares. “iShares Currency Hedged MSCI EAFE ETF”.

Source: https://www.thebalancemoney.com/how-to-invest-in-foreign-currency-1978918