The foreign exchange (forex) industry is the largest financial market worldwide, even larger than the stock market, with a daily volume of about $6.6 trillion, based on a 2019 bank survey. Even with such a volume, foreign exchange is not immune to risks. Numerous factors influence how currencies get traded and how they change in value. You can lose your forex investment if you’re not well-informed of such risks and developments. Learn forex trading to equip yourself with the knowledge you need to succeed in this activity.
How do you minimize the risks of having a foreign currency investment? Should you invest in countries that have strong currencies? How do you diversify your portfolio to reduce currency risk?
This article explains currency risk and discusses how to secure your funds from exposure to such a risk.
Securing Yourself From Foreign Exchange Risk
Foreign exchange risk refers to losses you may incur with your international financial transactions due to currency fluctuations. This risk affects businesses engaged in importing and exporting goods or services and investors trading in international markets. To minimize your exposure to foreign exchange risk, consider the following tips to secure your funds while trading foreign currency.
Invest in Countries With Stable Currencies
Some currencies are more volatile than others, meaning they’re likely to experience significant changes in value in a short period.
If you’re a casual forex investor, this instability can be challenging to monitor or forecast. To minimize this risk, look for countries with stable currencies, meaning you should invest in currencies that are strong relative to the currency in your country. If that foreign currency continues rising, your investment will have a higher value when converted to your home currency.
Some places to look for such forex investments are countries with historically conservative management and a low debt-to-gross domestic product (GDP) ratio. High debt levels can cause currency inflation. High inflation can hurt investor confidence in your local money and lower your currency’s value.
Diversify Your Portfolio Globally
Diversification means investing in more than one currency. This way, if one currency does not perform well, other currencies can help keep your portfolio in the green. Consider diversifying globally, such as with index funds exposed to large currency areas like the U.S., Euro region, and Asia-Pacific. Such diversified exposure allows you to build a natural hedge into your portfolio. For example, non-dollar investments will likely have a positive effect when the dollar is strong. Alternatively, weak non-dollar assets can benefit dollar-based investments.
Invest in Currency Hedge Funds
Hedge funds are partnerships of private investors wherein a professional fund manager manages the money and uses it for various strategies. These strategies include trading or leveraging non-traditional assets to earn above-average investment returns. Currency hedging helps reduce the currency fluctuation effects on investment performance. Thus, investing in currency hedged funds allows you to neutralize the currency risk while investing in a specific country’s or region’s stocks.
For example, you can buy a fund investing exclusively in Euro or Japanese stocks, which hedges the exposure on your behalf. Furthermore, predicting when a specific currency will rise or fall is a very challenging task to do by yourself, especially if you aren’t well-acquainted with the fast-paced currency movements. Since fund managers have the skills to manage hedge funds, it’s best to leave fund management to these professionals.
Consult a fund manager or financial advisor for helpful tips about forex trading, diversification, or hedge funds.
References
https://www.investopedia.com/articles/forex/11/who-trades-forex-and-why.asp
https://www.investopedia.com/terms/f/foreignexchangerisk.asp
