Fear the Forex Market

If you want to get exposure to currency changes, do so in a way that will limit your risk.
Author:
Publish date:

If you have to catch something that's going around, do whatever you can to make sure it's not the forex trading bug.

Although the offers of easy riches from swapping currencies might be tempting, the vast majority of investors would do well to resist the lure. Not only is this market supremely risky, but there are other, better ways to achieve the same investment goals.

That's not readily apparent to everyone, especially given the feeble performance of the U.S. dollar, which is down around 30% against the euro over the past five years. That has made betting against the greenback look like an appetizing one-way bet.

As the easy money of the housing market becomes a distant memory, a small industry of shops offering fast access to the forex market has sprung up like mushrooms in a dark, damp room, all hinting at the profits to be made by trading currencies.

To be sure, that possibility does exist. But the truth is, an individual is much more likely to lose, according to industry experts.

"I can categorically say that Joe Average has no place in the currency markets," says Morris Armstrong, who spent 23 years as a currency dealer and who is now a financial adviser at Armstrong Financial Strategies in Danbury, Conn.

More than $2 trillion of currency is bought and sold each business day across the globe, largely by very sophisticated operators with major technological advantages relative to the small investor -- think huge multinational banks like

Citigroup

(C) - Get Report

and

HSBC

(HBC)

or national monetary authorities, such as the Bank of England or the European Central Bank.

Also, the forex market is volatile, Armstrong says, and he points out that "margin can do some serious damage," especially to those without very deep pockets.

Trading on margin means borrowing money to pay for a large portion of the trade. While that leverage multiplies the gains, it also exaggerates the losses. Often, leverage is offered to currency clients by brokers, but if the market moves unfavorably enough, then the entire amount of the investment can be lost quickly.

So even if traders gets things right directionally or strategically, they can still lose money if the timing is wrong, says Dan Roe, chief investment officer at wealth management firm Budros Ruhlin & Roe in Columbus, Ohio.

That said, experts agree some exposure to foreign currencies can be a good way to reduce the overall riskiness of a portfolio. So now that you've been warned, what can you do?

Small investors might want to consider buying stocks of companies that would do well if the dollar stays weak, and perhaps even if it doesn't, says Jerry Miccolis, a financial adviser at Brinton Eaton Wealth Advisors in Morristown, N.J.

"Pick U.S. multinationals with lots of new growth potential," he says, highlighting

Coca-Cola

(KO) - Get Report

and

Procter & Gamble

(PG) - Get Report

as prime examples.

Investors get the double benefit of growing overseas markets, enhanced by the dollar story, because much of those firms' new business is coming from rapidly expanding emerging economies, he explains.

He also like the

iShares S&P Global Consumer Staples

(KXI) - Get Report

exchange-traded fund, which tracks a basket of consumer staples stocks across the globe.

A less leveraged way to gain currency exposure can be through foreign-denominated money market mutual funds. Roe owns the

(PLMDX)

Pimco Developing Local Markets fund, which is effectively an emerging-markets money market fund.

For those who are still keen on having direct currency exposure to a single currency, exchange-traded funds might be a simple way to go.

If you want to buy, for example, the Canadian dollar or Australian dollar, you can use the

CurrencyShares Canadian Dollar Trust

(FXC) - Get Report

or the

CurrencyShares Australian Dollar Trust

(FXA) - Get Report

. These ETFs attempt to track the value of the underlying currencies and are not leveraged.

In addition to the CurrencyShares ETFs, iPath has a similar family of single currency funds, including the

iPath GBP/USD Exchange Rate ETN

(GBB)

, which tracks the value of the British pound.