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Investing in currency a good idea?

Investment | Shares Helpful? 18

Asked by Moonfish, submitted 28 June 2010.

Open Quote As you have been mentioned all about different types of investment but there is one thing missing on your website. Forex! Have you ever experience this before? It is safe to invest money in forex? I know there is some risk in it but it may be worth to explore this type of investment. Many thanks.End Quote

Answered by Justin on 05 July 2010

Sorry for not replying sooner, was on hols last week.

I’ve not directly traded in foreign exchange (forex), but like most investors I have some exposure to currency movements through my overseas stockmarket investments.

For example, a fund investing in US shares will increase in value for a UK investor if the US dollar strengthens against the pound (because it will be worth more when converted from dollars to pounds). Of course the same investors would lose out if the dollar weakened against the pound.

You could also argue that currency movements affect UK stockmarket investors too, as around two thirds of the revenues earned by UK stockmarket listed companies come from overseas – although the impact on investment performance is less direct.

Of course, some investors like to invest in currency itself, rather than via other types of investment. Whether they make or lose money depends entirely on currency movements. In its simplest form you might buy £1,000 worth of US dollars at £1 = $1.50 (i.e. $1,500) expecting the pound to weaken against the dollar. If the exchange rate moves to £1 = $1.40 then your $1,500 would be worth £1071 – a £71 profit. But had the exchange rate moved to £1 = $1.60 you’d have lost £62.

Is speculating on currency movements a good idea? Like any investing it really depends on whether you fancy your chances of successfully guessing future movements. While easier said than done, some investors have been very successful doing so (e.g. George Soros). But it’s not without risk and there are plenty of investors who’ve lost money on currency bets.

When trying to guess future movements you need to take a view on future demand for a specific currency. Factors that affect demand are many, but common ones include:

  • Interest rates – high rates relative to other countries can attract demand.
  • Inflation – high inflation usually makes a currency less attractive.
  • International trade – if a country exports more than it imports demand for its currency is likely to increase.
  • International investment – investment money coming from overseas will probably push up demand.
  • Political and economic stability – if other countries believe a particular country is weak they probably won’t want to own its currency.

Money supply also matters. If a country’s central bank prints lots of extra money then it might diminish its worth versus other currencies.

To make money you’ll need to successfully guess which currencies are going to be in demand and which aren’t. Those where demand increases should appreciate relative to those out of favour, good news if you own the popular currency.

Also bear in mind that currency prices reflect the market’s future expectations. So usually it’s changes to those expectations, not what’s happening today, which have the biggest impact.

In practice it’s more practical to use exchange traded currency funds (ETF Securities has a range) or spread betting to try and profit from currency movements rather than buying and selling the currency (as foreign exchange brokers often build in a sizeable margin between buying and selling prices). Spread betting has the advantage of gains being free from tax, but it’s potentially higher risk as you could lose more than your initial stake.

Please note this answer does not constitute a recommendation or financial advice and should not be relied upon when making specific investment or other financial decisions. You should always undertake your own research into whether a product or service is appropriate for your needs and, if necessary, use a qualified professional adviser.

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