As global economies begin to right themselves, some economies and their respective currencies are bound to do better than others. Investors seeking to capitalize on the strengths of some currencies are turning to a viable alternative to direct forex investing with exchange traded funds (ETFs).
Currency ETFs have swiftly risen in the marketplace, with at least 38 such funds currently in existence and additional funds being added seemingly every month, remarks Adam Kritzer for CurrencyTrading.
Kritzer has provided an outline on how ETFs may be used for varying investing, trading and hedging strategies:
- ETF or ETN? ETNs posses a credit risk and may default if the issuer bankrupts. ETFs hold no credit risk, but have tracking risk – the returns may differ from the underlying index. (The difference between ETNs and ETFs).
- Saving or speculation? Currency ETFs pay a lower interest rate than one would receive from a savings account. However, the potential upside that comes from appreciations is what draws most investors.
- Individual or bulk currencies? Potential traders may decide between single-country currency ETFs or an ETF that covers a basket of currencies, which track a group or region of country currencies.
- Carry trade. Most single-country currency ETFs pay interest that mirrors interest rates offered in the country. So, a tightening of the monetary policies in the country could help lift the ETF. Traders may also play the lessening effects of carry trade by shorting high-yield currencies in favor of “safer” low-yielding ones. (Playing carry-trade ETFs).
- A gold hedge. Gold prices have historically risen/fallen inversely in relation to the U.S. dollar, and currency traders may protect themselves from a potential bubble by purchasing a dollar ETF. Or, if you are pessimistic about global currencies, you can always purchase commodities ETFs. (New record for gold).
- A stock market hedge. Currency ETFs may be used to hedge against a drop in stock prices. Countries with companies that are export-dependent would be constrained by an appreciating currency. An investor may hedge to offset conversion risks from investing in companies that conduct overseas business.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. 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.