Currency investing has recently attracted more interest as economic uncertainty has enveloped the globe. Historically, trading currencies was reserved to multi-national corporations and well-financed investors, but this market has been opened up to the average investor.
The foreign exchange market (forex) is where currencies are traded. For multinational companies, this market provides a means of doing business in other countries, facilitating the payment of bills in the local currency. For speculators, this market provides opportunities to take advantage of movements in exchange rates. Here are some reasons to consider investing in currencies.
- Diversification
You can use currencies to balance your portfolio, particularly if it is heavily focused in U.S. equities. For example, it you believe the dollar will drop in the future, you can buy one or more currencies that you think will rise.
One difference between stocks and currencies is that stocks move independently of each other while currencies move relative to each other. With currencies, when one is rising, another must be falling. - Level Playing Field
Unlike stocks, the news that drives currency prices is available to everyone on a real-time basis. In theory, there are no "insiders" in the foreign exchange market which operates 24 hours a day around the world. Since currency valuations are driven by actual monetary flows and events that influence a country's economic health, you can do your own analysis of how these events might impact its currency. - Global Economic Hedge
There is a growing fear that current U. S. fiscal and monetary policies will generate inflation and weaken the dollar over time. Growing budget deficits, record low interest rates and the amount of money being created by the Federal Reserve are all reasons for concern, and these developments are being closely tracked by currency traders. The currency market allows you to select currencies based on how you perceive their relative values will change over time. You can bet both ways, either long or short depending on which direction you think a particular currency is headed. You can allocate your risk across the currencies of several countries, allowing you to profit from changing global macroeconomic conditions. - Capital Appreciation
Currencies are akin to commodities and stocks because they offer the potential for capital appreciation. If the value of your currencies rises against the dollar, you will profit. If your currencies fall relative to the dollar, you will lose money. - Hedge Against Political and Event Risk
Currencies can be played against each other based on your tactical assessment of important events going on around the world. Examples are changes in top leadership, interest rate fluctuations, currency revaluations, wars, political upheavals, trading sanctions, new tariffs, monetary policy changes, trade deficits, recessions, tax changes, import restrictions and health-related epidemics.
Risk vs. Reward
Currencies are subject to risks that go well beyond the borders of each country, so an understanding of the interaction of global economies is important. Perception can be more important than reality since it's impossible to know exactly how critical world events will all play out once they start. Any of these events can happen in an instant without warning, making currencies subject to significant short-term volatility.
The risks and rewards of the forex market are amplified by leverage. Your potential profit or loss is multiplied by the leverage ratio, which can be in excess of 100:1. It's similar to trading stocks on margin because you can risk more money than the value of your capital account. This opens the door to profits on tiny moves in currencies if the trade goes in your favor, but your losses are multiplied if it goes in the wrong direction.
To minimize risk, spread your investment like you would with equities, choosing the currencies of countries that you are following closely. It's important that those countries have a stable financial and banking system. Also, if you are going to use leverage, start slow and work your way up
The Bottom Line
Before engaging in currency trading, consult with a broker who understands the markets and can help you determine if currencies are appropriate for your personal portfolio. While currencies have a reputation of being highly volatile, they actually trend with less volatility historically than many stocks.
Unless you are an experienced trader, it's not advisable to engage in currency day-trading. You will be up against professionals who make a living studying these markets. Over the longer-term, currencies provide another option for taking advantage of unfolding events on a global scale.
FAQs
Investing in currency can provide opportunities for diversification and potential profit by taking advantage of fluctuations in exchange rates. Understanding fundamental factors such as economic indicators, central bank policies, and geopolitical events is crucial for successful currency investing.
Why do people buy currency? ›
Currencies are akin to commodities and stocks because they offer the potential for capital appreciation. If the value of your currencies rises against the dollar, you will profit. If your currencies fall relative to the dollar, you will lose money.
Why are currencies important? ›
Regardless of the form it takes, all currency has the same basic goals: It helps encourage economic activity by increasing the market for various goods, and it enables consumers to store wealth and therefore address long-term needs.
What are two reasons a country's currency would appreciate? ›
Currency appreciation is an increase in the value of one currency in relation to another currency. Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances, and business cycles.
How to benefit from currency exchange? ›
An investor can make money in forex by appreciation in the value of the quoted currency or by a decrease in value of the base currency. Another perspective on currency trading comes from considering the position an investor is taking on each currency pair.
Which is the strongest currency to invest in? ›
The Kuwaiti dinar (KWD) is the world's strongest currency, and this is for a number of reasons. For starters, Kuwait has one of the largest oil reserves in the world.
What is a main reason for people to exchange currency? ›
By exchanging currencies, travelers can purchase goods using the currency that's most frequently accepted wherever they are visiting. Some people trade on the foreign exchange (forex) market to try and make money based on fluctuating exchange rates.
Why is currency worth anything? ›
Instead, it has value because of the trust people put in it to exchange goods and services, often by decree of a government authority. The U.S. dollar is an example of fiat money. The paper itself may not provide much value, but because others will accept it to trade commodities, you value it nonetheless.
Why do we value currency? ›
Our need to obtain the currency in order to pay our taxes generates demand for it. Once this universal demand within an economy is established, money is able to function as a medium of exchange and facilitate economic activity on a scale that wouldn't otherwise be possible.
What are the three purposes of currency? ›
To summarize, money has taken many forms through the ages, but money consistently has three functions: store of value, unit of account, and medium of exchange. Modern economies use fiat money-money that is neither a commodity nor represented or "backed" by a commodity.
Here is a list comprising the top ten most traded currencies in the world:
- US dollar (USD): ...
- Euro (EUR): ...
- 3. Japanese yen (JPY): ...
- The pound sterling (GBP): ...
- Australian dollar (AUD): ...
- Canadian dollar (CAD): ...
- Swiss franc (CHF): ...
- Chinese renminbi (CNH):
Money facilitates commercial transactions, enabling people to obtain the resources to survive and to thrive from others. Money functions as a medium of exchange to support these spot commercial transactions between buyers and sellers.
Who benefits from a strong currency? ›
A strengthening U.S. dollar means it can buy more foreign currency than before. For example, a strong dollar benefits Americans traveling overseas because $1 buys more; however, this would disadvantage foreign tourists visiting the U.S. because their currency would buy less.
What are the positive effects of currency appreciation? ›
For most people, a strong dollar or an increase in the exchange rate (appreciation) is preferable because it reduces inflation and lowers the cost of imports. People now have more purchasing power in the global economy as a result. This frequently results in higher living standards.
What 3 factors affect the value of a country's currency? ›
Summary. Currency value is determined by aggregate supply and demand. Supply and demand are influenced by a number of factors, including interest rates, inflation, capital flow, and money supply.
Is currency trading a good investment? ›
Forex trading may make you rich if you are a hedge fund with deep pockets or an unusually skilled currency trader. But for the average retail trader, rather than being an easy road to riches, forex trading can be a rocky highway to enormous losses and potential penury.
What are the benefits of trading in currency market? ›
The main benefits of trading forex are that it enables you to:
- Seize forex volatility.
- Trade around the clock.
- Go long or short.
- Capitalise on high liquidity.
- Make your money go further with leverage.
- Benefit from tax-efficient products like CFDs.
- Choose from a wide range of currency pairs.
- Hedge with forex.
Aliaga-Díaz: At a high level, an international reserve currency helps global investors and sovereign governments conduct critical transactions like settling payments for exports and imports of goods and services between nations, conduct global portfolio investments, borrow funds, and set prices for commodities such as ...
