Investing in foreign currency is a lucrative business. However, timing and choosing the currency to trade in is critical. Knowing when to buy, hold, and sell is crucial as well. Forex trading has a learning curve, and it has no shortcut. Start by investing small amounts or sign up for a demo account so you can learn how to trade in forex before investing substantial amounts.
Currencies are sold and purchased in pairs. The market is sensitive to global and local events. With such volatility, no one can claim to know the direction in which currencies will shift. Many factors could make a currency rise or fall, and this can happen in a matter of minutes.
To make smart, informed investments in foreign currencies, use these six tips on how to invest in foreign currency:
1. Use a currency broker
Investing in foreign currency is variously referred to as currency or forex trading. Since trading in forex is lightning fast, you have to be aware of the markets and how they respond to different scenarios. Due to the volatility of foreign currencies, knowing when to ask, hold, or buy is critical. In forex trading, you make profits in the margins, and timing is of the essence.
You also need to know which currencies to invest in. All these dynamics require thorough knowledge of the forex market. Although with time, you can learn how to trade effectively, you may have to consider using a broker at first.
You should also consider using a broker if your schedule does not allow you the flexibility to trade during your preferred hours. A forex broker trades every day on behalf of clients; this is what they do daily. They know which currency pairs to invest in and which ones to avoid. However, before settling on a forex broker, make sure they are legit. Only work with a trustworthy currency exchange provider to make sure your money is in safe hands!
2. Invest in a mutual fund or ETF
Investing in a mutual fund or ETF is a great tip for how to invest in foreign currency. As an investor, you can mitigate currency investment risks to a certain extent by buying into exchange-traded funds and mutual funds. They undertake the macroeconomic research on your behalf. ETF and mutual funds are great options for diversification.
They also rank currencies according to which one pays the highest interest rates. Without a mutual fund or an exchange-traded fund, you must be highly active since you would have to hold a currency until the monetary policies that govern the interest rates of that country change. After that, you can evaluate your options.
3. Diversify your currency investments
When investing in foreign currency, diversification is essential. The forex market can be extremely volatile. It responds to events such as political upheavals, elections, natural disasters, pandemics, and business news, among others. As such, today’s forex realities will not necessarily prevail tomorrow.
For this reason, you need to diversify to mitigate these risks. Diversification here simply refers to allocating investments across different financial instruments. When you diversify, you maximize returns as different investments react differently to changes in the market. Just like in fixed income or equity markets, diversification provides your portfolio with a safety net against unforeseen risks. It also makes achieving your investment goals a more realistic undertaking.
4. Only invest in stable currencies
Avoid investing in currencies from countries with punitive regulations and a high inflation history. Also, keep away from unstable governments that are not prudent with investments. For instance, Argentina once had a popular currency that was a darling of forex traders before the international currency crisis hit it hard, causing the country’s banking system to shut down in the 2000s.
At the moment, investing in currencies from Mexico, Chile or Brazil is a bit risky, but if the odds are in your favour, you are more likely to get a higher return on your investment compared to returns from the euro or the U.S. dollar.
Here is an easy way to explain the concept of forex trading: If the currency you have invested in appreciates, the appreciation is what you get as interest. But if the currency depreciates against the dollar, you don’t get any interest.
5. Invest in currency for the long term
Before investing in foreign currency, understand that forex trading is a highly volatile market. To make profits, you need a thorough understanding of different countries and the economic risks involved when investing in their currencies. Currencies are sensitive to risks such as unstable governments, nationalization programs, sovereign defaults, corruption, and expropriation. They’re also sensitive to economic risks like employment rates, GDP levels and inflation.
Apart from major currencies, such as the Swiss franc, the Japanese yen, the U.S. dollar and the British pound, the other currencies tend to be illiquid, which makes them risky investments.
Currency trading is not for everyone. This doesn’t mean you should not get involved. When making long-term investments, currencies aren’t riskier than investing in stocks. In any case, you can constantly monitor the currency to track its performance every few months.
6. Beware of levered currency investments
Several online trading and currency investment platforms have core businesses that provide a margin, or leverage, for currency trading. While this may, on the face of it, look attractive, it is inherently risky. To potentially mitigate losses, only purchase currency using cash. Timing the currency market is risky and difficult as the market is notoriously volatile.
Ignore the many ads that trumpet software or applications that claim to guarantee foreign-exchange trading profits. It is crucial to remember that, once in a while, even the most successful financial institutions incur losses when trading in currencies. Carefully consider which investment vehicle is best for you.