Currency ETFs 101

October 6th at 8:29am by Tom Lydon

Currency markets are among the sectors that exchange traded funds have opened up to investors, providing a liquid and transparent vehicle for trading currencies.

The ETFs can be used to diversify portfolios, but trading currencies is a notoriously risky and difficult endeavor.

Currency ETFs mirror the movements in the foreign exchange markets usually by holding cash deposits of the currency or by using futures contracts. Both have a high correlation to the actual currency over time, reports Esther Pak for Morningstar. Currency ETFs have also given all investors access to this once hard-to-reach area of the market.

There are two ways to go about a currency ETF investment. For one, there are country specific currency funds. An example is the CurrencyShares Swedish Krona (NYSEArca: FXS), which will play the upside of this currency against the movements of the U.S dollar. [ETF Chart of the Day: Leveraged Dollar ETFs]

Conversely, one way to play a rising U.S. dollar is with PowerShares DB U.S. Dollar Bullish (NYSEArca: UUP), which tracks the greenback against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. [Best ETFs for Rising Dollar]

An active currency strategy could be found with the PowerShares DB G10 Currency Harvest Fund (NYSEArca: DBV). The index plays the yield spreads by purchasing futures contracts in the highest yielding currencies of the G10, then sells futures of the three G10 currencies with the lowest yield.

Currency investing comes with inherent risk that touches upon the home country. Things such as geopolitical risk, national debt, trade deficits, interest rates, government default and commodity price swings are all factors that will have an impact on an investment in the currency market.

Read the disclaimer; Tom Lydon is a board member of the funds for Rydex|SGI.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.