In fact, stock investors are increasingly using currencies to hedge against risks with their stock portfolios. However, the problem with doing this is they have to manage their currency and stock investments separately, making this sort of diversification difficult to handle. New currency exchange-traded funds (ETFs) eliminate this problem. With a currency ETF, an ETF management firm buys currency pairs and holds them in a fund. The firm then sells shares in the ETF to individual investors, who can then buy and sell them in just the way that they buy and sell stocks. As the currency pair arises, the corresponding share price rises in tandem, and the share price falls as the currency falls.
To understand why investors are interested in using currencies rather than just buying other shares, it is important to know the different types of risk in the stock market. The first is what is known as idiosyncratic risk – the risk that any particular stock will fall. For instance, if a company reports poor results, the stock price will typically fall, even if its competitors are doing well. This type of risk can be managed by buying a broader basket of stocks. However, there is also systematic risk – the risk that the entire stock market will fall. You only need to look at the initial effects of the recent world economic crisis to see this type of risk in action.
Buying a broader range of stocks doesn’t combat systemic risk. However, investing in currencies can do exactly this. For example, consider the Swiss franc. In general, history has shown that the Swiss franc rises against the US dollar when bond yields fall. Since falling bond yields generally happen when the stock market falls, holding a position in CHF/USD can hedge against the risk of a bear market. Similarly, the Canadian dollar tends to rise as oil prices rise, since Canada is a major oil producer. Because of this, investing in a CAD/USD ETF can be used to hedge against the impact of higher energy prices on the stock market.
Editors’ Picks
GBP/USD stays weak near 1.2400 after UK Retail Sales data
GBP/USD stays vulnerable near 1.2400 early Friday, sitting at five-month troughs. The UK Retail Sales data came in mixed and added to the weakness in the pair. Risk-aversion on the Middle East escalation keeps the pair on the back foot.
EUR/USD extends its downside below 1.0650 on hawkish Fed remarks
The EUR/USD extends its downside around 1.0640 after retreating from weekly peaks of 1.0690 on Friday. The hawkish comments from Federal Reserve officials provide some support to the US Dollar.
Gold: Middle East war fears spark fresh XAU/USD rally, will it sustain?
Gold price is trading close to $2,400 early Friday, reversing from a fresh five-day high reached at $2,418 earlier in the Asian session. Despite the pullback, Gold price remains on track to book the fifth weekly gain in a row.
Bitcoin Price Outlook: All eyes on BTC as CNN calls halving the ‘World Cup for Bitcoin’
Bitcoin price remains the focus of traders and investors ahead of the halving, which is an important event expected to kick off the next bull market. Amid conflicting forecasts from analysts, an international media site has lauded the halving and what it means for the industry.
Israel vs. Iran: Fear of escalation grips risk markets
Recent reports of an Israeli aerial bombardment targeting a key nuclear facility in central Isfahan have sparked a significant shift out of risk assets and into safe-haven investments.
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