Currency trading through the foreign exchange market is an investment with low entry barriers, high liquidity and a 24-hour trading cycle for most of the week.
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While forex swaps currencies to make international payments, holiday spending, or to run an overseas business, they are also speculative investments.
Forex markets have a broad range of users, from individuals who trade via a broker, and brokers who facilitate transactions through banks. Banks also trade between themselves as part of everyday fund management or to finance demand for a particular currency.
How Currency Investment Works
Forex trading is a popular investment option, with lower transaction fees and minimum trades than are typically required to invest in stock markets.
The Financial Conduct Authority (FCA) regulates UK forex brokers and ensures they comply with regulatory requirements, such as:
- Caps on leverage – these are tighter for retail investors than institutional traders.
- Account protection through the Financial Services Compensation Scheme.
- Keeping client and company funds separate and submitting periodic reports.
Traders can choose to speculate on specific currency pairs, invest in exchange-traded funds (ETFs), or purchase mutual funds or exchange-traded notes; there are multiple potential investment options, each with varying risk versus reward.
Another route is to invest in shares in a multinational, with an inherent link to forex markets.
Risk is an essential consideration, because the liquidity and nature of forex mean that currency pairs can change swiftly. Although price movements are small and measured in fractions called pips, the outcome can be significant over larger trades.
The right investment approach also depends on how much capital you want to invest, the type of trading account you have, which will set standardised lot sizes for each position, and which investment approaches to take.
1. Forex Trading Through A Brokerage
The conventional way to invest in currencies is through a broker, where you open an account and pay commissions or a spread, where the difference between the ask and bid price is the broker’s take.
Forex trades work differently from other investments, with several standard formats and terms to be aware of:
- Currency pairs: it is impossible to invest in a singular currency because the currency you use to pay for the trade is also part of the equation. Currencies are traded in pairs, where you predict that one or the other will increase or decrease; these are known as long or short trades.
- Forex is a decentralised market, so there is no clearinghouse or central regulated exchange. Instead, you can choose from hundreds of independent brokers, although you should always select an FCA-regulated service.
- You can take a position of limitless size, calculated in lots. For example, one standard lot is 100,000 currency units, but there is no maximum number of lots you can take a position on.
- Leverage means that the broker lends you assets to expand the size of your trade – the amount available depends on the nature of the position and how much capital you have to put down as a deposit, called the margin.
Leverage is a core theme in forex trading but should be used cautiously. Although you can maximise your profits, you can also multiply losses.
2. Forex Certificates of Deposit
Certificates of deposit (CDs) work like a traditional savings account, but a forex CD offers returns of around twice those available from conventional CDs in your local currency.
The amount deposited earns interest from whichever currency you have invested in – usually a basket of investment products that combine different currencies, similar to a money market account.
CDs have a specific term length and provide a fixed rate of interest – the longer the term and the longer you wait for your investment to mature, the higher the interest you will usually make.
Income from a CD investment depends on the interest rates in the relevant currency – but there is a risk attached. If the prevailing interest rate changes dramatically between the time you open your CD and the date it matures, you are exposed to a loss.
- You invest in a two-year CD and receive 2.58 per cent interest.
- The selected currency is quoted at 0.77, so you deposit £7,700 to buy 10,000 units.
- Your calculated profit should be around £400, with an end balance of £8,100.
- If the local exchange rate changes to 0.900 from 0.77 over those two years, your £400 profit is now worth significantly less – you make a loss on the original deposit rather than a gain.
The same applies in reverse, where a currency can gain value over a CD term, increasing the profit available.
3. Foreign Currency Bonds
Bonds are fixed-income investment products whereby you lend your deposited capital to the bond issuer and earn a pre-agreed interest rate. For example, you might invest in corporate or government bonds and, in a forex context, would select a bond in a foreign currency.
The product works the same, but the idea is that you seek to expand the profit made by selecting a bond in another denomination that you anticipate will increase in value before the bond matures.
This type of investment is a way to achieve stable, fixed returns but attempt to maximise the value of the interest received by selecting an international bond with a different currency than your own.
There is also the potential to sell at a higher price, which may be a viable option if the currency appreciates, and the bond – and associated interest earnings – are now more valuable.
However, bond yields can fall, and the return you receive is generally lower than the gains made through stock investments.
4. Indirect Forex Investment
Indirect investments mean you participate to some extent in the currency market without making specific decisions about which currency pairs to trade or when to enter or exit a position.
The simplest option is to invest in shares with a multinational structure. There are countless examples, from retail chains to food and drink brands, technology companies and the gaming industry.
Much depends on whether you wish to select shares with listed businesses that engage in forex trades with particular currencies or whether you are looking for a tiny element of forex exposure.
Suppose your stocks experience a favourable currency climate, when profits are converted back into the base currency for reporting. In that case, you will see a benefit in share value and potential dividend distributions.
5. Forex ETFs and ETNs
Exchange-traded notes (ETNs) work like a corporate bond but have a comparable risk exposure through the forex market as an ETF or exchange-traded fund. Investors trade both currency ETNs and ETFs through the same forex exchanges.
ETFs can include stocks, shares, equities, commodities, currencies, bonds, and indices. ETNs vary because they act like a debt secured to an asset rather than a unit of the underlying asset itself.
An ETF is a financial asset traded like a stock and provides an opportunity to invest in currencies without necessarily selling on the foreign exchange market.
Both products are exchange-traded, i.e., traded on the stock exchange, and involve investing your funds into a pool with other investors, in essence, buying units of the fund.
In terms of risk, ETNs usually are higher risk because you could lose all your invested capital if the issuer cannot pay out, whereas ETFs can fluctuate in value if the assets in the fund drop.
Ways To Invest In Currencies FAQ
The forex market is easy to access, even for novice investors. It is open nearly all the time, overcoming issues such as time differences and available hours that preclude traders from engaging in some other exchanges.
Returns can be subject to high risk, but the transaction fees are low due to the market’s high liquidity.
Every foreign currency transaction holds currency risk, which is the potential for a currency to change in relation to how the other side of the currency pair is trading.
There are also transaction risks, which mean that investors can experience losses if the transaction and settlement dates differ, and the currency pair moves within that time.
Suppose you trade forex directly or indirectly with established funds, regulated brokers, or respected platforms. In that case, the investment process is safe – although it does not diminish the risk of a trade failing.
One of the biggest concerns for forex traders is that high leverage, designed to boost profits, could backfire and multiply the losses made.
There are pros and cons to foreign currency investment. Still, if you use a reputable broker and spend plenty of time analysing reports and forecasts, you should be in an excellent position to make long-term financial decisions.
The correct answer depends on your preferences, risk acceptance and investment strategy – all potential investments listed here are feasible ways to dip your toes into the forex world.
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