Currency exchange traded funds (ETFs) have grown extremely popular as investors look for some shelter from the recent whipsaws of the stock market. These ETFs are usually less volatile and show longer, more defined trends than stock indexes.

However, it is important to understand and know what to expect from currency ETFs before investing in them, as Anthony Welch for Index Universe explains.

Welch first points out that currency ETFs are not substitutes for money markets. Currency ETFs can and often do fluctuate in value, despite most of them paying monthly interest.

Similarly, currency ETFs are not substitutes for bonds. This is because bonds have a fixed date where an investor expects a return of principal. Meanwhile, currencies can decline for long periods of time and possibly never get back to the highs they once achieved. As a result, currencies are not something investors can buy and hold in the long run with a true degree certainty.

Currencies are also not similar to stocks. The currency market is enormous, being that currencies trade 24 hours a day and represent all the money in the world in a sense. Unlike most stocks, many currency traders have reasons to trade without the intention to make money, but rather to hedge risk.

Although currency ETFs are not like money markets, bonds, or stocks, they are very simple. Currency ETFs are nothing more than a relationship between two currencies, one of them usually being the U.S. dollar. These relationships fluctuate based on an extenuating number of circumstances ranging from interest rates, political climate and economic and GDP activity.

Some of the many Currency ETFs include:

• CurrencyShares Australian Dollar Trust (FXA), up 3.3% year-to-date
• CurrencyShares Euro Trust (FXE), up 4.2% year-to-date
• WisdomTree Dreyfus South African Rand (SZR), down 1% since July 8 inception
• WisdomTree Dreyfus Japanese Yen (JYF), down 4.5% since May 22 inception
• PowerShares DB US Dollar Index Bearish (UDN), up 1.9% year-to-date
• PowerShares DB US Dollar Index Bullish (UUP), down 0.4% year-to-date

For full disclosure, some of Tom Lydon’s clients own shares of UUP.

Read the disclosure, as Tom Lydon is a board member of Rydex Investments.

Tags: Australian Dollar, Bond ETFs, Currency ETFs, Euro, FXA, FXE, Japanese Yen, JYF, Mexican Peso, South African Rand, SZR, UDN, UUP