From investors to financial experts, everyone is of the opinion that you need to diversify your investment portfolio. It’s the most clichéd thing that you’ll hear from them. Of course, there are the usual methods of putting money in the stock market, conservative bonds and even in international markets.
But if you’re itching to add something more to your investment portfolio, then why not trading in foreign currencies?
Dominated by institutional investors and banks at one time, trading and investing in the foreign exchange market was seen as a very risky proposition and was only open to them since it involved large sums of money. But online brokerages and margin trading accounts that are readily available now have changed all of that.
Individual investors can now access the capital and trade in the foreign exchange market at the click of a button.
But before you take the plunge, here are a few things that you need to consider:
Advantages of Trading in Foreign Currencies
One of the biggest advantages of trading in foreign currencies is that even if the economy in your country isn’t doing that well, you still stand a chance of making some money. You’re probably thinking, but what if the market declines? Well, you can still bet against different currencies and trade when you think it’s the best time for you.
For instance, if the US dollar is not doing that well as compared to the Chinese Renminbi, you can trade your Renminbi and cash in on the additional US dollars that you’ll make.
Another big advantage is that the foreign currency market is open 24 hours a day. Some of the major trading hubs are opening and closing throughout the numerous time zones. So you don’t need to wait for opening and closing times like the stock market.
Let’s say you’re working full time and find time only in the evenings to trade in the foreign currency market. If you’re based in the US, you can easily trade in the Asian markets.
Risks of Trading in Foreign Currencies
Investing and trading in the foreign currency market certainly sounds very interesting. But you still need to do your due diligence before you invest in any foreign currencies. Just like any other type of investments, there’s no guarantee that you’ll make all your money back.
But in spite of the risks involved in trading in foreign currencies, they are not as high as any other type of investments. Although you’ll lose your money, you can limit that amount by investing in a smaller amount in the first place. This means if you put in $5,000, the maximum that you can lose is $5,000 and nothing more. In short, don’t invest more money than you’re willing to lose.
There are many ways to start trading in foreign currencies. Forex is one of the most popular. It’s definitely difficult to thoroughly research the foreign markets abroad. So forex trading will give you a general idea of how you can invest your hard-earned money.
For instance, you can read and get information on why Asia is a booming market. It can help you in determining if you want to consider investing in any Asian currency. However, it may be hard to get information on Chinese companies since most of the details will be in Chinese. Unless you’re fluent in Chinese or have translated the information, there’s no way to decide.
One of the other reasons why it’s easier to use forex is that most people investing in forex concentrate on six major types of currency combination as follows:
- New Zealand Dollar and US Dollar
- Australian Dollar and US Dollar
- US Dollar and Canadian Dollar
- US Dollar and Japanese Yen
- British Pounds and US Dollar
- Euros and US Dollar
In the stock market, you’ll have more than 10,000 stock options to pick from and decide the best ones for you. However, in forex, you only need to keep an eye on the above eight countries and their political and economic updates. Any major event and the currencies will fluctuate. That is when you’ll need to buy or sell the foreign currencies to make money.
One very popular way of gaining exposure to the forex markets is by opening a multi-currency account or a bank account in another country and funding it. You can then transfer money into the relevant currency and hold it there. When sending the money from your home country to the new bank, make sure you research the different rates that currency brokers are offering. Also, never use your bank for the transfer as the fees are typically extortionate.
Foreign Currency Futures
Another option to trade in foreign currency is foreign currency futures. These are essentially futures contracts on currencies. They are bought and sold based on a settlement date and a standard size. Foreign currency options is another avenue to invest in foreign currency.
Exchange-traded funds or ETFs are also one of the simplest ways to invest in foreign currency. These funds buy and manage a portfolio of currencies on behalf of you. Often tools like futures contracts and swaps are used for this purpose. The advantage is that you’ll not have as much leverage-related risk. Buying funds can be done by a traditional stock broker. You don’t really have to look for a foreign exchange broker.
Foreign Bond Funds
Foreign bond funds are yet another way that you can invest in foreign currency. There are certain mutual funds that invest in foreign government bonds. They can earn interest denominated in the foreign currency. If the foreign currency that you’ve invested in were to go up in value relative to your local currency, then the earned interest would also increase when converted back to your local currency.
Some of the funds that you can consider investing in are Templeton Global Bond Fund, Aberdeen Global Income Fund and Merk Hard Currency Fund.
If you’re planning to trade actively only then investing in the foreign currencies will make sense. As you may already know that the foreign currency rates fluctuate on a daily basis. Hence, they are extremely volatile in nature. This is why foreign currency investments are better suited for active traders and not anyone who plans to make it a long-term investment.