PROFITING FROM CURRENCY ETFS
Normally, if a trader wishes to profit from changes in currencies, he should either open a forex account or purchase the currencies. But there is a simpler way to gain benefit from changes in currencies — the Currency ETF. Such funds seek to mirror movements in the forex market by holding currencies directly or through currency-denominated short-term debt instruments. Before going into details, let us look back at why currencies tick.
What makes these currencies rise and fall? In forex, the exchange rate will escalate or decline since the value of each other fluctuates against another. Factors affecting a currency’s value include economic growth, government debt levels, trade levels, oil and gold prices, and the political condition, among others.
What is Currency ETF? As mentioned earlier, this fund replicates the movements of a currency in the forex market, either by holding currency cash deposits in the currency being trailed, or through futures contracts on the underlying currency. Whichever, these should give a highly correlated return to the actual currency movements over time. Usually, these funds offer low management fees since it only entails minimal management. But traders should always be wary of these fees before purchasing.
How do currency ETFs work? For the longest time, several investors have being using exchange-traded funds to track major equity indexes such as the S&P 500. These funds have few advantages over mutual funds such as flexibility, greater transparency, easier to trade, and tax efficiency. Traders can invest in currencies like in stocks or any other ETFs through currency ETF, not to mention these funds can be obtained in an individual retirement account (IRA).
Basically, there are various currency ETFs available in the marketplace. One can purchase ETFs which track individual currencies. For example, the US dollar tracked by the PowerShares DB US Dollar Index Bearish. There is also a fund which tracks a basket of different currencies including the PowerShares DB US Dollar Index Bullish trailing the greenback up or down against other major currencies. Currency ETFs follow most major currencies. Aside from the US dollar, it also tracks the price movements of the Australian dollar, the British pound, the Canadian dollar, the euro, the Japanese yen, the Swedish krona, and the Swiss franc.
Like any other ETFs, if the foreign currency appreciates against the US dollar, the trader will earn a profit. Or the trader will end up with a loss if the fund’s currency or underlying index drops relative to the greenback.
But there are corresponding currency risks that affect the currency ETFs including national debt, political conflicts, interest rate changes, trade deficits, government defaults, commodity price changes, changing domestic and foreign interest rates, and central banks or other government agencies that sell a currency in huge volumes. As a currency trader, it is important to recognize these perils and its potential effect on the price of your fund, and to neutralize these risks to your advantage.
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