Bank for International Settlements (BIS) data indicate that the global foreign exchange markets boast over $4 trillion in average daily trading volume, making it the world's largest financial market.
The forex market entices traders of all levels, from novices just learning about the financial markets to well-seasoned professionals. With nearly round-the-clock trading sessions, access to considerable leverage and low costs, it is relatively easy to enter the forex arena. Current economic conditions and volatility in the overall markets, however, can be intimidating to the forex trader. Fortunately, traders have a variety of choices, including more conservative plays, when it comes to investing in currencies. (If forex interests you read How To Become A Successful Forex Trader.)
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Foreign Currency Certificates of Deposit
The interest rates in the U.S. are so low right now that it is difficult to make any money off certificates of deposit (CD). That said, they do offer a safe place for money; investors may not earn much, but they will not lose any money either. Another option for certificates of deposit that may provide the opportunity to earn higher interest rates is the foreign currency CD.
EverBank offers a WorldCurrency CD that earns interest rates based on the local rates of a specific country or a basket CD that offers exposure to a variety of currencies. These foreign currency CDs are subject to fluctuations in exchange rates, but generally offer higher interest rates than dollar-denominated CDs. Investors can lose money if the dollar strengthens against the foreign currency as the CD matures.
Only U.S.-based FDIC-insured banks should be used; in fact, many websites that offer foreign currency CDs at fantastic rates are scams. The FDIC insurance protects against bank insolvency, but not against the currency price fluctuations so money can be lost in this type of CD.
Currency Exchange Traded Funds
Exchange traded funds, commonly referred to as ETFs, are investment funds that are traded on a stock exchange. Investors have a wide variety of ETFs from which to choose including those that track a major market Index, target gold or track a basket of foreign currencies. Currency ETFs provide investors with exposure to a particular currency or a basket of currencies, allowing access to multiple foreign currencies.
In 2005, Rydex SGI launched CurrencyShares Euro Trust (NYSE:FXE), the first currency exchange-traded fund. Since then, there has been significant growth in the entire currency ETF market, with assets of all funds now totaling more than $6 billion. Approximately 40 funds are now available that offer investors currency exposure.
The largest of the currency ETFs is the PowerShares DB U.S. Dollar Index Bullish (NYSE:UUP) with $1.05 billion in net assets. Incidentally, an advantage in trading ETFs is that they can be shorted, so investors could actually short the bullish fund if they felt the dollar was headed down. The fund invests by going long USDX futures contracts (to replicate the performance of being long the U.S. dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc). (To learn more about Currency ETF, read Profit From Forex With Currency ETFs.)
The demand for U.S. currency has waned worldwide as developing economies like China begin to pay for cross-border transactions using domestic currency rather than dollars. As the demand abroad decreases, the supply of dollars has grown as a result of the Federal Reserve Board's second round of quantitative easing efforts that pumped a total of $900 billion into the money supply. The changing climate has some foreign exchange investors looking towards new markets for trading opportunities.
Investors and traders can play the emerging markets in a number of ways, including emerging market exchange traded funds or directly in an emerging economy's currency, such as the Hong Kong dollar, Singapore dollar, South African rand and the Brazilian real.
WidsomTree Dreyfus Emerging Currency Fund (NYSE:CEW), for example, has more than $599 million in net assets and is an actively managed fund that invests in eight to 12 emerging markets currencies currently including those found in Latin America (Brazilian real, Chilean peso and Mexican peso); Europe, Middle East and Africa (Polish zloty, Russian ruble, South African rand and Turkish new lira) and Asia (Chinese yuan, Indian rupee, Indonesian rupiah, Malaysian ringgit and South Korean won).
Currency futures are futures contracts where the underlying commodity is a currency exchange rate. These contracts offer investors the ability to enter the foreign exchange market in an environment that is similar to other futures contracts. Currency futures, also called forex futures or foreign exchange futures, are exchange-traded futures contracts to buy or sell a specified amount of a particular currency at a set price and date in the future. Like other futures products, currency futures are traded in terms of contract months with maturity dates falling in March (H), June (M), September (U) and December (Z).
Popular currency futures contracts include:
- AUD/USD Futures (Australian dollar/US dollar)
- CAD/USD Futures (Canadian dollar/US dollar)
- EUR/USD Futures (Euro/US dollar)
- GBP/USD Futures (British pound/US dollar)
- CHF/USD Futures (Swiss franc/US dollar)
- EUR/GBP Futures (Euro/British pound)
- EUR/CHF Futures (Euro/Swiss franc)
- EUR/JPY Futures (Euro/Japanese yen)
- JPY/USD Futures (Japanese yen/US dollar)
- NZD/USD Futures (New Zealand dollar/US dollar)
An advantage in trading the currency futures markets is that they are regulated the same way as other futures markets. They have a great deal more oversight than the spot forex market which is largely unregulated. Currency futures brokers must follow regulations enforced by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).
The Bottom Line
The foreign currency market is the largest financial market in the world. Investors who are interested in exposure to this market have many options. Each investor should adequately research investment opportunities and consult with a qualified advisor before making any investment decisions. (To start investing in forex, see Getting Started In Forex.)
Please note: At the time of publication, the author did not hold any positions in any instrument mentioned in this column.