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. Mutual Funds & ETFs

    ETF Analysis: First Trust Dorsey Wright Focus 5

    Take a closer look at the First Trust Dorsey Wright Focus 5 ETF, a unique and innovative fund of funds based on momentum and relative strength.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares National AMT-Free Muni Bond

    Take an in-depth look at the iShares National AMT-Free Municipal Bond ETF, a highly diverse and very popular muni bond fund.
  3. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  4. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  5. Mutual Funds & ETFs

    7 Best ETF Trading Strategies for Beginners

    Exchange-traded funds are ideal instruments for beginning traders and investors. Learn the seven best strategies for trading ETFs.
  6. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares JPMorgan USD Emerg Markets Bond

    Learn about the iShares JPMorgan USD Emerging Markets Bond fund, which invests in bonds of sovereign and quasi-sovereign entities from emerging markets.
  8. Active Trading Fundamentals

    How Hedge Funds Front-Run Index Funds to Profit

    Understand what front running is, and learn how hedge funds use this investing strategy to profit from the anticipated stock buys of index funds.
  9. Mutual Funds & ETFs

    ETN Analysis: Rogers Intl Commodity Energy Total Return

    Learn more about the Rogers International Commodity Total Return, which is an exchange-traded note that tracks a broad index of commodity futures.
  10. Mutual Funds & ETFs

    ETF Analysis: Schwab US Large-Cap

    Discover how the Schwab U.S. Large-Cap exchange-traded fund is managed, the index it tracks and the investors for which it is most appropriate.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Lion economies

    A nickname given to Africa's growing economies.
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!