The best way to diversify a portfolio by investing in foreign currency is to do so. Forex trading is more complicated than trading stocks or mutual fund shares or building your investment strategy with bonds. But, knowing the basics will give you a good foundation for building on if this asset class is one you are interested. This guide will walk you through all the basics of currency investing. A advisor can answer your questions about investment in currency and other forms of capital.
Foreign Currency Investing: What Is It?
To invest in currency, you must first buy the currency from one country before selling the currency from another. This can be done through the ” foreign forex”.
Forex trading occurs in pairs. In order for a transaction to be completed, one currency needs to be exchanged. One example would be to buy U.S. currency and sell British pounds. Although it is technically possible to exchange any foreign currency for another on the market, it’s much more common to trade using predetermined pairings.
Here’s a typical way foreign currencies are grouped.
- Major Pairings:This category includes the most often traded currencies. Usually, this group includes the U.S. currency (USD), euros(EUR), Japanese yense (JPY), British pounds (GBP), and U.S. pound (GBP).
- Minor matchings:This group also contains many of the currency pairs in the major pairings category. USD is not included.
- ExoticsThis is where you will often see pairings of a heavily traded and a relatively inactive currency. USD might be paired with the Singapore dollar (SGD) or Hong Kong dollar.
- Regional pairings In this category currencies are paired together depending on where they are located. One might see Asian and European currencies exchanging hands for one another in the same geographic area.
Why you should invest in Currency
Forex trading seeks out to capitalize upon fluctuations in foreign currency values. It’s similar in concept to trading stocks. You want your currency to grow in value, so you can make a profit when you sell it. Your profit tied the currency’s foreign exchange rate. This ratio is the amount of currency’s value compared to another .
If you’re looking at pairings, it may be worth considering how they are ordered. For example, USD/GBP would be the base currency for a USD/GBP pairing. GBP, on the other hand, is the quote currency. The exchange rate determines how much you will have to pay for the base currency in order to purchase it. A currency pairing is when you buy base currency and sell quote currency.
The Mechanics of Investing In Currency
Stocks or mutual funds are traded on a centralized market, such the Nasdaq and New York Stock Exchange. Forex is not. Instead, Forex is traded through the foreign forex market, which is managed banks and other financial institution. All trades are conducted electronically and can be done at any hour of the day or night.
Forex trading can only be done through an agent. There are three methods to trade foreign currency.
- Spot-trading: When a trade is settled, currency pairs will be exchanged. This is essentially instant-trading and the spot prices represent the price at that a currency can buy or sell.
- Forward currency trading:When you purchase or sell foreign currency in advance, you agree at a certain price and on a particular date. The spot price will settle and you will be protected against volatility when it is time to trade.
- Future-trading:Future traders are very similar to forward trading. However, there is one key difference. A Future Trading Contract will legally obligate you to make the trade. The foreign currency rate will determine the cost of the contract.
Once you’ve made a decision about how to trade it, you decide whether or not to buy. You might consider the impact of the exchange rate on your decision. If you’re purchasing a pairing you can expect the base currencies to increase in value. If you sell a pair, you are selling the base currency but buying the quote. You are also hoping that the value of the base currency will decrease so that you can buy it back for a better price.
Bid and Questions
The bid and the ask are forex terms all investors should be aware of. The price at which a broker will purchase a foreign exchange pair from you is known as the bid. The broker’s asking for a certain currency. Spread is the difference in prices between them. Knowing the meaning of these terms can help you read forex quotes, and understand the price per trade.
The following is an example of a quote to a pair:
EUR/USD = 1.2545/1.2572
The bid is determined by the first number. For one euro, the broker would give you 1.2545 Dollars. The second number is called the ask. This means that the broker wants to charge 1.2572 for one U.S. dollars.
Pros/Cons of Forex Trading
Currency investment can have many benefits.
- Stock exchanges offer convenience and accessibility during set hours. Trade pre- and post market are possible, but not 24/7. Forex trades, however, can be made any time of day or night.
- DiversificationDiversifying a portfolio can help reduce risk. Foreign currency can be a good alternative to mutual funds, bonds, stocks, or other assets.
- Lower costs: Foreign currency trading is likely to have lower commissions than stocks trading. This allows for you to retain more of your profits.
There is one major drawback to currency investments:
- High potential volatility: Forex trading can be lucrative but it is more volatile than the stock exchange. Beginners may face a steep learning curve. These risks could be greater than with other investment strategies. Therefore, it’s important that you carefully assess your risk tolerance before investing.
Bottomline
It’s possible to invest in foreign currency for the first time. However, it is important to be familiar with how it works. It is helpful to be able to see how foreign currencies are affected by movements in broader stock markets, geopolitical considerations and the economic environment in countries you are interested. To make informed decisions regarding currency trades, you need to know as much as possible.
