The foreign exchange market is the world’s largest financial market, accounting for more than $7.5 trillion in turnover each day. This market is comprised of banks, commercial companies, central banks, investment firms, hedge funds, and retail investors. Participants can buy, sell, exchange, and speculate on currencies. Interested in diving in but unsure how? This article highlights some of the key ways to invest in the foreign exchange market.
Key Takeaways
- The foreign exchange market is the largest, most liquid market in the world.
- There are many opportunities to trade forex, including options and futures.
- ETFs and ETNs are traded on exchanges and mirror the returns of an index or benchmark.
- Forex CDs help investors earn interest at foreign exchange rates.
- Investors can choose to invest in foreign bond funds denominated in different currencies.
Foreign Exchange
The forex market is a 24-hour cash (spot) market where currency pairs are traded. Because currencies are traded in pairs, investors and traders bet one currency will go up and the other will go down. The currencies are bought and sold according to the current price or exchange rate.
The world’s most traded currency pair is the euro versus the U.S. dollar (EUR/USD). Daily trade volume in this currency pair made up 24% in 2019.
Other popular currency pairs include:
- JPY/USD
- GBP/USD
- AUD/USD
- CAD/USD
Foreign Currency Futures
Foreign currency futures are futures contracts on currencies. These are exchange-traded financial derivatives that are bought and sold based on a standard size and settlement date. Contracts specify the price in one currency at which another currency can be bought or sold at a future date. Currency futures are commonly used to hedge currency risks or traders may use them to speculate on movements in currency prices.
The Chicago Mercantile Exchange (CME) Group is the largest foreign currency futures market in the U.S. It offers futures contracts on G10 as well as emerging market currency pairs and e-micro products.
Consider opening a demo account, using a trading simulator, or making paper trades before you jump into trading currencies in the forex market.
Foreign Currency Options
While futures contracts represent an obligation to either buy or sell a currency at a future date, foreign currency options give the option holder the right (but not the obligation) to buy or sell a fixed amount of a foreign currency at a specified price on or before a specified future date.
Investors can trade foreign currency call and put options:
- Traders buy FX call options when they believe the base currency will get stronger compared to the quote currency. They sell FX call options when they believe the quote currency will rise against the base currency.
- Traders buy FX put options when they think the quote currency will rise against the base currency. They sell FX put options when they think the base currency will rise against the quote currency.
Exchange-Traded Funds (ETFs) and Exchange-Traded Notes (ETNs)
Exchange-traded funds (ETFs) and exchange-traded notes (ETNs) are designed to mirror the returns of an index or other benchmark. Both ETFs and ETNs trade on stock exchanges like stocks. The key difference between the two is that, unlike an ETF, an ETN doesn’t own the underlying asset. Rather, it is an unsecured debt note issued by a bank or financial institution.
Forex ETFs and ETNs provide exposure to foreign exchange markets. Some ETFs are single-currency, while others buy and manage a group of currencies.
Certificates of Deposit (CDs)
Foreign currency certificates of deposit (CDs) are available on individual currencies or baskets of currencies and allow investors to earn interest at foreign rates. For example, EverBank offers a range of currency-related CD options, including:
- New World Energy CD Basket, which provides exposure to the Australian dollar (AUD), Canadian dollar (CAD), and Norwegian krone (NOK)
- Global High Yield, which provides exposure to the Brazilian real (BRL), Indian rupee (INR), Mexican peso (MXN), and South African rand (ZAR)
- Viking, which offers investors exposure to the Danish krone (DKK), Norwegian krone (NOK), and Swedish krone (SEK)
Foreign Bond Funds
Foreign bond funds are mutual funds that invest in the bonds of foreign governments. Foreign bonds are typically denominated in the currency of the country of sale. If the value of the foreign currency rises relative to the investor’s local currency, the earned interest will increase when it is converted.
How Big Is the Foreign Exchange Market?
The foreign exchange market is the largest and most liquid market in the world. According to the Bank for International Settlements, daily global trading in this market reached $7.5 trillion in 2022.
What Are Some of the Pros and Cons of Trading Currencies?
The foreign exchange market is open 24 hours a day, five days a week, which gives you flexibility in your trading. The market is very liquid and comes with low transaction costs. Keep in mind, though, that this market is decentralized. As such, it is largely unregulated, which means it can increase your chance of counterparty risk. There is also a greater risk for fraud.
Do You Need to Be Experienced to Trade Currencies?
It’s always a good idea to have some experience when you start trading any asset, including currencies. If you want to make money in the foreign exchange market, you want to ensure that you have discipline and a tolerance for risk and loss. If you’re a newbie, consider paper trading or using a platform that offers a simulated trading environment so you can practice making trades.
The Bottom Line
There are multiple options available for anyone who wants to trade currencies. You can take advantage of currency exchange rates by investing in any of the options highlighted above. But, trading currencies can be as risky a venture as it can be profitable. You have to have some level of experience and discipline before you dive in. That’s why it’s important to take the time to understand how the market works and to practice trading to mitigate your losses.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.
