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May Q&A: Available now
This month, the Making Sense team answers client questions related to trade policy developments and their impacts on key economic issues.
If you want more diversification and international exposure for your portfolio, one option is to invest in foreign currencies.Â
This strategy requires research and carries more risk than traditional investments. When done correctly, and in alignment with your risk tolerance, it can potentially yield high returns.
With foreign currency trading, you buy and sell different currencies based on their exchange rate. For example, let's say the current euro to USD rate is 1.098. That means one euro costs $1.098. If you think the value of the euro will go up, you can sell dollars and buy euros.
You can also make investments outside your own currency. For example, if you're American, you can invest based on the value of the Japanese yen to the euro or on the Canadian dollar against the British pound. You sell the currency you think will lose value and buy into the one you think will go up.
Some investment brokers specialize in foreign currency trading. You deposit money into their account, and then you can use their platform to research, buy and sell into different currencies. There are a few different ways to actually trade these currencies.
Investing in foreign currency has a few key differences versus other investments like stocks, bonds and mutual funds.
You can only trade stocks, bonds and mutual funds when the markets are open, which is during normal business hours in the US. With foreign currency trading, you can make these investments any time a foreign currency market is open somewhere in the world, which is most of the time.
Leverage is when you borrow money short-term for an investment. This may increase your gains, but also your losses. It's more common to see leverage with currency trading, so that small price moves lead to bigger results. For example, you might use 50-to-1 leverage, so a 0.1% increase in your exchange rate could lead to a 5% investment gain.
Currency markets are constantly in flux, especially when you consider all the countries in the world with exchange rates. As a result, it's an active market with lots of trading, versus stocks and mutual funds where it's more common to buy and hold. Just bear in mind that more opportunities to trade also means more potential costs you might incur in fees—be sure to monitor these to avoid letting your overall costs get too high.
When you factor in leveraging and the volatility of international markets, foreign currency trading can be fairly high-risk, depending on the economic environment. Taking a more cautious approach will help you avoid large losses.
Foreign currency can be a good fit for sophisticated investors willing to put in lots of research. You'll be competing against some tough investors, including Wall Street professionals, so you need the skills to keep up.
Investors typically need to have a high risk tolerance for investing in foreign currency. If you're scared to lose money and don't want a complicated trading strategy, investing in foreign currency likely isn't the right fit. And if you're new and just starting to invest, you might want to master the fundamentals before you invest in foreign currency.
There are many courses and videos online to explain foreign currency trading. They can teach you the basics along with investment strategies. You can contact your financial advisor to see if they can give you advice and recommendations about foreign currency trading. You could also use a currency fund and leave this trading in the hands of the fund manager.
Whichever way you go, use foreign currency trading as an addition to your portfolio, not the core strategy. This way, you can safely use these funds to potentially gain some extra upside without risking the bulk of your savings over compromising the overall health of your financial plan.
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