Currency trading is a relatively new option for non-professional investors. For years these financial choices have been the domain of Wall Street currency desks who could handle the large amount of money trading every day. The spread of computer technologies and the internet have allowed everyone access to currency markets. In addition, currency futures and ETFs have come along to ease an investor’s transition to currencies.
Forex, which stands for foreign exchange, is the most straight forward way to trade currencies. Many online Forex brokers have arisen over the past decade allowing almost anyone to get involved in this market. However, just because you can trade using Forex doesn’t mean you should. Investors using Forex trade in two different currencies, one they go long and one they short. In essence, the investor uses one currency to buy the other. However, the investor doesn’t need to own the currency they are selling to buy the other. Each trade is worth $100,000. Many traders don’t have enough capital to invest $100,000 in one trade. That’s why Forex brokers allow investors to use a much larger amount of leverage in their trades, sometimes 100:1 or more. Leverage this large means an investment of $1000 can buy $100,000 worth of Euros, Pounds, or any other traded currency. It also means a small downturn in the investment of 1% makes the investment worthless. Only investors who understand Forex should trade this market.
Another way to trade currencies involves the futures market. A futures contract gives the owner a certain amount of a commodity, whether it is oil, wheat, or currencies, at a specific month. Like Forex, each contract is for a large amount, usually over 100,000 units of the currency being purchased. Many traders in contracts also use leverage, although usually nowhere near the extent of Forex traders. The Chicago Mercantile Exchange is the biggest currency futures market in the United States. Investors shouldn’t trade in futures without consulting their financial advisor.
ETFs, or exchange traded funds, are the last way for investors to gain exposure to different currencies. ETFs are a recent invention of the latest bull market; they give investors access to alternative investments they otherwise couldn’t invest in. Commodities, market indices, and foreign markets are just some of the areas ETFs cover. And although they are ran like mutual funds, ETFs trade like stocks, giving investors instant liquidity and tradability for a very small fee. There are more than one ETF for the major currency pairs like the dollar (American, Australian, and Canadian), the euro, and the pound. Companies like Barclays and Wisdom Tree run these ETFs.
The area where ETFs really shine is special options unavailable to even investors using Forex or futures without entering into complex trades. Some ETFs are leveraged to provide two or three times the gain a regular currency ETF would give. There are also ETFs that allow investors to go short a specific currency or bet against a specific currency like the dollar. Finally, there are ETFs that allows investors who hold a basket of different currencies without investing in all of them individually.
Any investor without access to the currency markets is missing something from their portfolio. While each method has its positives and negatives, ETFs are probably the cheapest and safest way for most investors to trade currencies. They don’t require a large capital position or any leverage at all. So, if you feel a certain currency is on the move, don’t be afraid to express your opinion with ETFs.