Foreign Currency ETFs
Foreign currencies are a great way for traders to make some money in addition to them being good for those investors looking to either hedge portfolio currency risk or get exposure to a particular country’s currency.
Nevertheless, one of the drawbacks of foreign currency trading is the difficulty of the transaction. An investor has to be pretty sophisticated to succeed. He or she will have to not only watch out for arbitrage opportunities, but also be conversant with currency options and futures. Not to mention the must have 10 decimal point calculator to not let the math get to you when trading currencies. It truly takes some savvy and know-how to be a successful currency trader.
This is why currency ETFs come in handy. They basically takeaway the complexity.
What are Currency ETFs?
Currency ETFs are basically a simple way to give your portfolio the foreign currency exposure you want in the absence of the complexities. A currency ETF works by tracking a particular currency, comparable to how a normal ETF tracks a certain index.
Currency ETFs are intended to follow one currency, or sometimes a basket of currencies. The latter provides investors with exposure to several foreign currencies.
What makes up a Currency ETF?
A currency ETF is fundamental composed of either a string of currency futures contracts made to follow the price of a very specific currency or in some cases the ETF is made up of cash deposits of the currency being emulated.
Whatever it is, the exchange traded fund is designed with the idea of tracking the trajectory of a foreign currency, without attempting to do better than it.
- We can buy and sell foreign currency ETFs
- Buy a currency ETF when there is reason to be bullish
- Sell a currency ETF when there is reason to be bearish
- Make money and mitigate currency risk both ways
The Cases for Buying and Selling a Currency ETF
The Case for Buying a Currency ETF
Trading and investing in foreign currencies is just that much easier with currency ETFs as they remove the extraneous fees and the rather tough calculations that come with it. So basically, if the market indicates like it does right now that the U.S. dollar will outperform the yen, then it is time to consider buying an ETF that tracks the Dollar like the PowerShares DB US Dollar Index Bullish ETF (UUP).
Or take the case of the U.S. dollar falling relative to the other major foreign currencies. In this case, it makes a lot of sense to buy an inverse currency ETF like the PowerShares DB U.S. Dollar Bearish ETF (UDN) that will allow you to benefit from the downside risk.
The Case for Selling a Currency ETF
We live in a global economy and a lot of investors are vested in foreign markets, and often times they have to carefully consider protecting any downside risk to their portfolio. It takes a lot of work to manage a portfolio of this scale and you would have to scour the news to stay up to date with any political risks or worse a civil war drug war that could cause some serious losses. Selling an ETF that follows a region’s currency is a good idea in this case.
In addition to political implications, there are economic risks that must be considered like a trade deficit, interest rate changes and also commodity price fluctuations in a single country (due to embargos, tariffs, etc). A short position is a nice way to protect against the many factors that can cause currency market risk.
Start Investing in Currency ETFs Now
As with forex trading, its best to start with the majors. So take a look at some of the primary ETFs and ETNs before diving in. If you want to save on taxes, then currency ETFs are the way to go. This is a relatively new ETF trading strategy and I would encourage investors and traders to get well-versed with it. They may not be as advanced as other ETF investing strategies like options, but they do have their advantages.
Nonetheless, there are risks as well as no investment is perfect. Still, currency ETFs are very close to a perfect investment.
I'll leave you here with a nice list of Currency ETFs to choose from.
List of Currency ETFs and ETNs
Foreign Currency ETF
PowerShares DB US Dollar Index Bullish ETF
Tracks the U.S. dollar against a basket of developed-markets currencies. Great for hedging
FactorShares 2X S&P500 Bull/USD Bear ETF
Investors that are bullish on large cap stocks will love this leverage ETF!
PowerShares US Dollar Bearish ETF
The opposite of the UUP
iPath EUR / USD Exchange Rate ETN
Gives investors exposure to the euro/U.S. dollar exchange rate
iPath GBP/USD Exchange Rate ETN
Provides investors with exposure to the GBP/U.S. dollar exchange rate
ELEMENTS British Pound /USD Exchange Rate ETN
Great ETF for those bullish on the GBP/USD