By John Nyaradi
Europe has been all the news lately, along with the Euro Dollar, and volatility like this offers quick profit-making opportunities in various asset classes that investors might otherwise not consider.
Exchange Traded Funds (ETFs) offer investors the ultimate in flexibility and portfolio construction by making previously unavailable asset classes easily accessible to retail investors. One of these major asset classes is Forex which, until recently, has been the domain of specialists, and traders/investors have been required to open separate accounts and trade forex as a separate segment of their investment portfolio.
However, with the advent of ETFs, investors can now get exposure to the benefits (and risks) of forex trading in traditional brokerage accounts, including IRAs and qualified defined contribution and 401k accounts.
Many investment avenues are available when using currency ETFs. One can go “long” a particular currency with standard currency ETFs or one can “short” a currency, either by shorting the particular ETF or buying an “inverse” ETF that changes value in the opposite direction of the underlying index. One can also leverage positions with ETFs that offer 2X leverage to the underlying currency’s index. Finally, ETFs that simulate the action of currency pairs are available which can replicate the trading action of the underlying forex pairs themselves.
Currency ETFs trade just like a stock and move with the underlying foreign exchange rate and offer a convenient, easy to understand way to participate in this market. While there are differences between currency ETFs and spot forex trading, ETFs offer investors several unique advantages. One example of a common forex ETF is the Currency Shares Euro Trust (AMEX:FXE). In light of the current European situation, last week provided investors significant gains as policymakers dodged the Greek bullet once more.
chart courtesy of www.stockcharts.com
Furthermore, you can use currency ETFs within the confines of a standard brokerage account and so all of the things you’re used to with a standard stock account apply to currency ETFs. ETFs allow margin, short selling, stop loss entry and exit opportunities and reasonable commission structures. Currency ETFs also offer standard stock market margin leverage, and for more aggressive investors, options strategies on currency ETFs are available including covered calls and buying either puts or calls to amplify potential returns.
Beyond single currency ETFs, investors can also use currency pair exchange traded funds that are available in major markets including the British Pound/U.S. Dollar (GBP/USD) Euro/U.S. dollar (EUR/USD) and U.S. Dollar/Japanese Yen (USD/JPY).
Like all currency pairs, these ETFs reflect the relative value of the two currencies and fluctuate in value as the underlying relationship of the currencies changes. In the case of the EUR/USD, for instance, when the Euro appreciates relative to the U.S. Dollar, the value of the ETF increases and when the Euro loses value to the dollar, the ETF declines in price.
Investors also can get exposure to the so called “carry trade” via the Barclays Capital Intelligent Carry Index that is designed to capture returns from investing in high yielding currencies with money financed by borrowing low yielding currencies. The Barclays Optimized Currency Carry ETN (AMEX:ICI) uses a pool of currencies for this strategy, which includes major currencies like the U.S. Dollar, Japanese yen, Euro, Swiss Franc, British Pound, and Australian and New Zealand Dollar.
chart courtesy of www.stockcharts.com
So it’s easy to see that currency exchange traded funds offer a simple, convenient way for investors to develop and deploy a potent and flexible arsenal in the world of foreign exchange trading. With ongoing volatility in world markets and unprecedented governmental intervention across the globe, we can expect these conditions to continue for sometime. For investors armed with the right weapons, currency trading can offer unique opportunities during these unique times.
Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds and positions can change at any time.