The stock market has been volatile in 2010 and a large number of investors are beginning to move out of equities because they cannot take the ups and downs. It isn't easy to mitigate the volatility, but there is a way to lower the overall beta of a portfolio by adding alternative asset classes such as commodities and currencies.

IN PICTURES: Top 10 Forex Trading Rules

The world of currencies often referred to as the FX market is the largest and most liquid market in the world. Most investors overlook the opportunities due to lack of knowledge about how to trade currencies and their benefits to diversification. However, since most major currencies can now be accessed through exchange-traded funds (ETFs), the world of FX trading is now open to everyone.

The Greenback
The U.S. dollar is typically the currency used to base the movement of other foreign currencies. For example the euro will be priced versus the U.S. dollar when quoted on the major financial websites and media outlets. The U.S. Dollar Index, which tracks the price of the greenback versus a basket of foreign currencies, broke a nearly decade long downtrend in early 2008 and has since been extremely volatile.


Weakness in the euro after the near blowup of Greece in early 2010 helped the U.S. Dollar Index rally to one-year highs before weakening again in the second half of 2010. There are two ETFs that allow investors to play the U.S. Dollar Index to the upside and downside. The PowerShares DB US Dollar Index Bullish ETF (NYSE:UUP) will move with the index. The PowerShares DB US Dollar Bearish ETF (NYSE:UDN) moves in the opposite direction of the index. For example if the U.S. Dollar Index falls by 10%, ideally UDN will rise 10%.

Euro, Yen and Pound
The euro took a major hit, falling 15% in the first six months of 2010 before attempting a rally. In June the euro was trading at the lowest level in over four years and over 25% lower than the all-time high in 2008. The Rydex CurrencyShares Euro ETF (NYSE:FXE) tracks the euro versus the U.S. dollar and if you were lucky enough to be short the euro in 2010 it was a great hedge against stock market weakness. (For more, see The Currency Market Information Edge.)


One of the best hedges for a weak US stock market has been the Japanese Yen, which can be tracked for investors through the Rydex CurrencyShares Japanese Yen ETF (NYSE:FXY). After hitting a high on 4/23/10, the S&P 500 has fallen 11% and during the same timeframe FXY has gained 9%. A 20% differential in less than four months is significant. FXY recently broke out to a multi-year high before pulling back in mid-August.

A currency that has been out of favor for quite some time is the British pound, accessible through the Rydex CurrencyShares British Pound Sterling ETF (NYSE:FXB). The ETF began to fall in late 2007 and has yet to put together a sustainable rally off the lows. However, as of late it has been picking up with the rally in the euro, so it may be one to watch.

Emerging Market Currencies
The introduction of emerging market currency ETFs has brought on more investment opportunities, but they have yet to catch on. Investors have access to the Brazilian real, Chinese yuan and the Indian rupee to name a few. My suggestion to play this space is the Wisdom Tree Emerging Currency ETF (NYSE:CEW) that invests in a basket of emerging market currencies including the yuan, rupee, real, Chilean peso, and South Korean won to name a few. In all the ETF invests in 11 emerging currencies. (For more, see Forex Currencies: Emerging Market Currencies.)


Diversification Made Easy
The introduction of currency ETFs have allowed the average investor the ability to diversify away from equities without having to open an FX account. Along with diversification, the currency ETFs also could help hedge against a market sell-off and even make money in tough economic times. (For related reading, see Forex Trading: Using The Big Picture.)


Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Chart Advisor

    Watch This ETF For Signs Of A Reversal (BCX)

    Trying to determine if the commodity markets are ready for a bounce? Take a look at the analysis of this ETF to find out if now is the time to buy.
  2. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  3. Mutual Funds & ETFs

    ETFs Can Be Safe Investments, If Used Correctly

    Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs.
  4. Mutual Funds & ETFs

    The Top 5 Large Cap Core ETFs for 2016 (VUG, SPLV)

    Look out for these five ETFs in 2016, and learn why investors should closely watch how the Federal Reserve moves heading into the new year.
  5. Economics

    India: Why it Might Pay to Be Bullish Right Now

    Many investors are bullish on India for all the right reasons. Does it present an investing opportunity?
  6. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  7. Investing Basics

    Building My Portfolio with BlackRock ETFs and Mutual Funds (ITOT, IXUS)

    Find out how to construct the ideal investment portfolio utilizing BlackRock's tools, resources and its popular low-cost exchange-traded funds (ETFs).
  8. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  9. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  10. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
RELATED FAQS
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center