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

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Mutual Funds & ETFs

    Buying Vanguard Mutual Funds Vs. ETFs

    Learn about the differences between Vanguard's mutual fund and ETF products, and discover which may be more appropriate for investors.
  4. Mutual Funds & ETFs

    ETFs Vs. Mutual Funds: Choosing For Your Retirement

    Learn about the difference between using mutual funds versus ETFs for retirement, including which investment strategies and goals are best served by each.
  5. Mutual Funds & ETFs

    How to Reinvest Dividends from ETFs

    Learn about reinvesting ETF dividends, including the benefits and drawbacks of dividend reinvestment plans (DRIPs) and manual reinvestment.
  6. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  7. Mutual Funds & ETFs

    Best 3 Vanguard Funds that Track the Top 500 Companies

    Discover the three Vanguard funds tracking the S&P 500 Index, and learn about the characteristics and historical statistics of these funds.
  8. Forex Fundamentals

    How to Buy Chinese Yuan

    Discover the different options that are available to investors who want to obtain exposure to the Chinese yuan, including ETFs and ETNs.
  9. Mutual Funds & ETFs

    ETF Fees: Why BlackRock is the Latest to Cut Them

    Low expense ratios are a big selling point for ETFs, but are they being focused on too much?
  10. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  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 >>

You May Also Like

Trading Center