Currency Investment On Foreign Exchange As An Essential Tool For Diversification of a Conservative Portfolio

In this day and age, the usual mix of investments in equity and bonds can no longer be the only component of the portfolio — simply because it can no longer provide the desired safety of capital. The world’s markets have become so interdependent that all asset classes are now very correlated. This means that they rise and fall together, fully exposing the investor to global risks. Diversification of one’s holdings has never been as important and hard to implement as it is now.

True diversification is still reachable, and the way is to include currency investments and active trading strategies into one’s portfolio. Currency investment takes many forms, from the very conservative buy-and-hold of government bonds nominated in foreign currencies to short-term speculation on forex. Currencies are remarkable in their non-correlation with stocks. For example, while the Dow has lost 34% in 2008 (Jan 01 to Dec 31), the Japanese Yen gained 23% in the same time period. Of course, currencies can follow stocks as well. It is important to note that currency exchange rates are affected by different factors than stocks. A stock has a natural tendency to follow the company’s earnings. If the company grows its business, the stock price follows. Currencies don’t do that. Their value is mostly determined by actions of the issuing central banks and relative inflation. Consequently, the main difference between stocks and currencies is that stocks in general can be expected to grow long-term, while currencies change fast in respect to each other, following the general direction to lower purchasing power because of global inflation.

Because of this, holding currencies for extended periods of time is more risky than implementing a short term active forex trading strategy. Gains and losses realized in currency trading do not necessarily depend on the direction of the market, but are determined by the strategy itself. For example, a strategy built to trade short in bear market rallies can perform exceptionally well in the current environment with the dollar — but more importantly, it will add a negatively correlated component to the portfolio. Brokers provide a number of ways to implement an active trading strategy, including highly automated forex online trading terminals that have the ability to automatically analyze the market and place orders.

Although investing in currencies carries many advantages, including protection from loss of the purchasing power of the dollar, it is also a highly risky endeavor. Investing in currencies is different from investing in the stock market, and requires a skill set that most retail investors don’t have. This is precisely the reason why investment in currency is not recommended to clients by mainstream financial advisors – they consider it best to be safe than sorry and, frankly, this advice is the best one for many people whose itch to get rich fast overcomes their ability to reason.

However, when used as a diversification and hedging tool rather than a high risk speculative instrument, forex trading has a legitimate place in a portfolio. It is easy to get a first hand impression — any broker will be happy to offer a free forex demo account for practice, without any obligations.

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