The Basics of Currency Investing

Right now, the money in your wallet is losing its value.

And worse, there's nothing you can do to stop the U.S. dollar from utter freefall because...

  • The Federal Reserve's expansive monetary policy is flooding the banking system with cash, diluting the dollar's value.
  • The U.S. government is intentionally devaluing the dollar to make its exports more affordable.
  • China is recruiting a host of other countries in its drive to stamp the dollar out of international trade.

(To learn more about the death of the dollar - and find out specific ways to protect your retirement - take a look at our new U.S. dollar report, right here.)

But, you don't have to just sit on the sidelines and watch your money lose value. Instead, you can look to investments in foreign currencies.

This isn't an investing plan for the feint of heart. Currency investing is one of the riskiest monetary gambles you can make.

But, if you have a little "play money" burning a hole in your bank account, currency investing could be a great way to try for sky-high returns.

Here's your quick guide to currency investing...

Currency Investing Basics

For starters, you need to know the term FOREX.

Short for Foreign Exchange Market, FOREX is an international exchange where global currencies are bought and sold. The market value of currencies traded on FOREX is based on supply and demand.

FOREX is the largest liquid financial market (daily trading reaches between $1 trillion to $1.5 trillion), meaning two things: First, you'll be able to find a buyer or seller within seconds at nearly any hour of the day; Second, such large volume means you won't see volatile price swings. Rather, such volume creates a larger quantity of small fluctuations in currency values, which can be viewed as a treasure trove or minefield for an investor depending on his/her experience and strategy.

Unlike a standard market like the New York Stock Exchange, currency trades take place in all corners of the world through telecommunication. And it's done 24 hours a day from Sunday afternoon until Friday afternoon, as there are currency dealers around the world who will quote all major currencies.

So say you decide you want to buy the Brazilian Real, you track down a dealer via your broker and punch in your order. This can be done with an account of your own money, or by starting a marginal trading account.

Marginal trading is trading with borrowed capital, allowing you to invest more, avoid transfer costs and open larger positions. You can borrow up to $100,000 at a very low interest rate (often under 1.0%).

When you close a position, the amount you borrowed is returned, and your profit or loss is calculated and credited to your account.

Technical vs. Fundamental Analysis

There are two basic approaches to investing on FOREX - technical analysis and fundamental analysis.

Despite what its name suggests, technical analysis is a strategy more often used by beginner-to-novice currency investors. Its basic premise is that all possible factors of a currency's value have been digested and factored in by the market, resulting in the current price of that currency. What investors then do with that data is find out patterns - if currency price movements are caused by certain events, and if those events will repeat themselves.

Fundamental analysis takes such data and adds another level of specific data gathering to it. An investor using fundamental analysis will make trades after looking at a multitude of factors happening within the country of a currency - its economic and political situations, central bank interest rate, unemployment level, rate of inflation - that have an effect on its currency.

Making Money on Money

Again, we need to emphasize that the majority of retail investors should leave currency trading to those who have a firm grasp on the currency market and have a high tolerance for risk.

Likewise, we're not going to suggest specific currencies to buy because it's recommended new and novice currency investors take a technical strategic approach as mentioned above.

But, a good place to start would be one of the many new currency exchange-traded funds (ETFs) recently made available. Just as the ETF market catered to the growing demand to invest in overseas companies and indices, so too has it responded with ways to invest in foreign currencies as the U.S. dollar crumbles.

Currency-focused ETFs eliminate two of the biggest challenges of currency investing.

First, you can buy and sell them the same way you do with common stocks. Second, an investment company such as Wisdom Tree manages the fund, so you don't have to be constantly vigilant in keeping track of currency fluctuations and relationships around the globe.

But because ETFs trade like stocks, you'll likely be charged per trade like you would if you were buying or selling stock through your broker. And given currencies' small daily fluctuation range, it's very unlikely you'll see a huge one-day gain for any given currency. So you'd be throwing away money in trade charges if you buy and sell currency ETFs as frequently as you would trade actual currencies on a daily basis.

In that sense, currency ETFs are more like currency "investments" as opposed to daily, or hourly, currency trades.

If this route sounds appealing, you're next challenge is picking from the many currency ETFs on the market.

ETF provider WisdomTree offers and manages several foreign currency ETFs - from as broad as its Dreyfus Emerging Currency Fund (NYSE:CEW) (great for those who like to play emerging markets) to as specific as its Dreyfus New Zealand Dollar Fund (NYSE: BNZ).

Rydex Investments' roster of currency ETFs leans more toward investing in liquid currencies, such as its CurrencyShares Euro Trust (NYSE:FXE), CurrencyShares Australian Dollar Trust (NYSE:FXA), CurrencyShares Canadian Dollar Trust (NYSE:FXC) and CurrencyShares Japanese Yen Trust (NYSE:FXY).

Invesco PowerShares offers three currency products: PowerShares DB US Dollar Bearish Fund (NYSE:UDN) if you think the dollar's going to continue falling, PowerShares DB US Dollar Bullish Fund (NYSE:UUP) if you think the dollar's about to bounce and PowerShares DB G10 Currency Harvest Fund (NYSE:DBV) to bet on a basket of currencies from some of the world's largest and most powerful economies.

And lastly, and most speculatively of the ETF options, ProShares offers leveraged currency ETFs in which you can bet for or against a particular currency, such as its ProShares Ultra Yen (NYSE:YCL), which returns double the gains on the yen, and its ProShares UltraShort Yen (NYSE:YCS), which goes up twice as much as the yen falls.

Once you've grown more knowledgeable and comfortable with the global currencies and FOREX, the next stepping stone could be Zecco, an online brokerage that gives clients the option to trade FOREX either by themselves or with the assistance of brokers.

And if you'd like to know exactly what's in store for the U.S. dollar, take a look at our latest dollar report right here.