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Investing In Currencies On Foreign Exchange As An Essential Tool For Diversification of a Conservative Portfolio

In the current market situation, the usual mix of investments in equity and bonds can no longer comprise 100% of one’s 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, leaving the investor unprotected from global negative developments. Diversification of one’s holdings is more important now than ever, and equally hard to achieve.

The way to achieve true diversification 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. Currency value does not depend on the health of a country’s economy as much as on the actions of the issuing central bank and inflation. Consequently, the main difference between stocks and currencies is that stocks in general can be expected to grow long-term, while currencies are all losing their purchasing power at different speeds, and their foreign exchange rates can change directions quickly.

Because of this, it is best to approach currencies with short to medium-term active trading strategies on forex. Gains and losses realized in currency trading do not necessarily depend on the direction of the market, but are determined by the strategy itself. The properties of a trading strategy can be designed in a way that would guarantee low or negative correlation with the rest of the portfolio, no matter which direction the market takes. Brokers provide a number of ways to implement an active trading strategy, including highly automated online forex 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 not something that should be undertaken lightly. Investing in currencies is not similar to the more conventional forms of investment, and certain skills must be developed in order to invest successfully. 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, a prudent investor must at least be aware of the possibilities offered by currencies. 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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