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
EUR/USD steady below 1.0800 after US PCE meets expectations
EUR/USD remains depressed below 1.0800 after soft French inflation data, amid minimal volatility and thin liquidity on Good Friday. The pair barely reacted to US PCE inflation data, with the Greenback shedding some pips. Fed Chair Jerome Powell set to speak ahead of the weekly close.
GBP/USD hovers around 1.2620 in dull trading
GBP/USD trades sideways above 1.2600 amid a widespread holiday restraining action across financial markets. Investors took a long weekend ahead of critical United States employment data next week. Fed Chair Powell coming up next.
Gold price sits at all-time highs above $2,230
Gold price holds near a fresh all-time high at $2,236 in thinned trading amid the Easter Holiday. Most major world markets remain closed, although the United States published core PCE inflation, the Federal Reserve’s favorite inflation gauge.
Jito price could hit $6 as JTO coils up inside this bullish pattern
Jito (JTO) price has been on an uptrend since forming a local bottom in early January. Since then, JTO has revisited the key swing point formed in early December, suggesting the bulls’ intention to move higher.
Key events in developed markets next week
Next week, the main focus will be inflation and the labour market in the Eurozone. We expect services inflation to be impacted by the easter effect, while the unemployment rate to be unchanged.
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