The foreign exchange market, or forex, is where the world’s currencies are traded 24 hours a day. For some, it’s simply a way to swap one currency for another. Multinational corporations that conduct business globally rely on the forex. The market is also home to traders who bet on the continual movements of currencies relative to one another.
The forex, by the way, doesn’t exist in the physical world. It’s purely an electronic entity, with no home base and no owner. The forex market operates between individuals represented by brokers, between brokers and banks, and between banks.
If you are a casual investor, dipping into the world of currency traders may not appeal. But there are still ways to participate in this market.
Key Takeaways
- Any investor can open a trading account on a forex broker’s site.
- Alternatives include mutual funds, exchange-traded funds (ETFs), or exchange-traded notes (ETNs) that focus on exploiting foreign currency movements.
- Less direct currency plays include foreign bond funds and the stocks of global corporations.
- Investing in currencies is relatively risky, especially during volatile economic times and periods of high geopolitical tension.
1. Standard Forex Trading Account
Investors can open an account with a forex broker and trade currencies from around the world. The forex market operates differently from a stock exchange:
- Currencies are traded in pairs and the investor is betting one will go up, or long, and the other will go down, or short.
- The forex is not a regulated exchange and there is no central clearinghouse for trades.
- There is no uptick rule for taking short positions.
- There is no upper limit on the size of a position.
- Currency dealers generally make money on the bid-ask spread rather than on commissions.
2. CDs and Savings Accounts
EverBank offers a WorldCurrency certificate of deposit (CD) that earns interest at local rates in specific countries. It also offers a basket CD that includes a mix of various currencies and a foreign currency account that functions like a money market account and allows the transfer of money between major currencies.
The CDs are subject to exchange rate fluctuations but offer a higher interest rate than dollar-denominated CDs. When the CD matures, an investor will get back fewer dollars than they deposited if the dollar strengthened against the foreign currency.
FDIC insurance protects against bank insolvency but not the currency risk.
3. Foreign Bond Funds
Another alternative is investing in a mutual fund that buys foreign government bonds. These mutual funds earn interest denominated in foreign currency. If the foreign currency goes up in value relative to local currency, the earned interest increases when converted back to local currency.
There is a wide range of foreign bond funds, allowing the investor to select their preferred level of risk.
Examples of such funds include BlackRock’s Strategic Global Bond Fund, the Fidelity International Bond Index Fund, and the Vanguard Total International Bond Index Fund.
4. Multinational Corporations
Many stockholders indirectly participate in the foreign currency markets through their ownership in companies that do significant business in foreign countries. Some of the better-known American companies with overseas exposure are Coca-Cola, McDonald’s, IBM, and Walmart.
The revenues and profits derived from overseas operations are boosted if the foreign currency appreciates versus the dollar. This is because those revenues are converted back into dollars for financial reporting purposes, and a stronger foreign currency will yield more dollars in exchange.
5. ETFs and ETNs
Exchange-traded funds (ETFs) and exchange-traded notes (ETNs) are traded like stocks and can be a way to invest in currencies without needing to trade the forex. With a standard investing account with most brokerages, investors can buy access to currency ETFs such as UUP, the Invesco DB US Dollar Index Bullish Fund, or EUO, the ProShares UltraShort Euro.
ETNs are similar to corporate bonds, but they tend to have a similar exposure to the currency market as ETFs. On the same exchange, investors trade ETFs, they can also find common currency ETNs such as the iPath GBP/USD Exchange Rate ETN (GBBEF).
Opportunities and Risks of Forex Trading
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Forex trading is very popular, so markets typically have high liquidity with low transaction fees.
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Investors diversify their portfolio by gain assets outside of their normal trading location.
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Traders can enter highly leveraged trades, potentially multiplying profit.
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Forex markets run all day long, and investors can trade whenever they want.
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No central exchange or regulator controls the market.
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Traders don’t have much transparency due to the deregulated nature of the market.
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Forex rates are influenced by many factors; the process of determining the price of a currency is complex.
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Traders can enter highly leveraged trades, potentially multiplying losses.
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Forex markets have historically been highly volatile.
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Unlike with stocks, forex trades often don’t have access to portfolio advisors.
What Are the Benefits and Drawbacks of Investing in Foreign Currency?
The forex market provides easy access for beginners. Since it’s a global market, trading is available around the clock. Transaction fees are normally low because it’s a market with high liquidity.
That said, a casual investor can invest in currencies without learning the complex workings of the forex. There are less risky choices such as currency funds and the stocks of global blue-chip companies.
What Are the Risks of Investing in Foreign Currency?
Exchange-rate risk, or currency risk, occurs when the price of one currency changes relative to another’s. Transaction risk is the loss that can occur due to delays between the transaction and the settlement of trades.
Other risks such as political risk are specific to the underlying currencies losing value due to economic or government events.
That said, the most widely traded currency pairs on the forex are the ones that are seen as the least likely to implode, including the euro versus the U.S. dollar, the U.S. dollar versus the Japanese yen, and the British pound versus the U.S. dollar.
How Safe is Forex Trading?
The foreign exchange currency market is volatile and carries substantial risks.
Some traders use high leverage, magnifying their potential losses.
Also, it is important to identify a reputable forex broker to avoid scams.
The Bottom Line
The values of currencies change constantly, reacting to world events. The Internet and wireless communications provide almost instant access for investors.
Investing in currencies can provide diversification for people who invest primarily in U.S. securities. There are ways to take advantage of currency movements without directly trading on the forex. These include investing in stock or bond funds with an international focus or buying the stocks of U.S.-based companies that do business around the world.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.
