How to Play $1K: Cash In With Currencies

Editor's note: Not drowning in debt? Have $1,000 to put to work? senior correspondent and You're So Money author Farnoosh Torabi checks out foreign currencies.

Senior year of college my finance professor decided to shift gears from studying the Capital Asset Pricing Model and introduce us to the wonderful world of currencies. Terrific, I thought; a chance to learn about foreign economies and international politics. Instead, what followed was a series of intense math lessons on currency swaps.

I couldn't keep up (read: stay awake). What about learning the histories of different currencies and having a currency show and tell? Besides, back in 2001, investing in the U.S. dollar was the way to go for the most part. Why bother to learn the math? Our currency ruled.

That was then. Now, with the U.S. dollar recently tracking near an all-time low against the euro and other foreign currencies, I wish I had paid closer attention to my professor (and had the foresight) to hedge against a weak dollar.

But it's not too late, experts say. With the world's currencies strengthening, there are countless opportunities to make money, so that's how I'm going to "play $1K" this time: currency exchange.

I understand that playing the currencies should really only be done with "risk capital," as experts say it's such a volatile and time-sensitive market. "It can be enormously profitable but you have to be willing to experience big risk," says Marc Prosser, chief marketing officer of Forex Capital Markets, an online currency broker. Alright. I am prepared to lose my "how to play $1K" of capital. It should be worth the lesson.

Homeland Homework

" Buying currency is like you're buying shares of an economy," says Prosser. They represent the overall health and performance of a nation, starting with economic growth. Interest rates one of the greatest indicators to that end. When a country's interest rate rises, saving money in that country becomes more lucrative. Many investors use this relationship as a first step in targeting fruitful currencies. Websites like and offer an updated chart of world interest rates. Turkey, for example, has a relatively high interest rate of about 16.75%. Brazil has a 12.25% rate.

Keeping on top of the latest policies and forecasts from a country's central bank -- just like the U.S. Federal Reserve -- is also recommended.

Beyond interest rates, it's important to evaluate a country's gross domestic product ( GDP) growth. For example, if a country's GDP is climbing rapidly, that may lead to inflationary risks and possibly later, higher interest rates to curb some demand and boost savings.

Additionally, you need to evaluate a country's geopolitical and sociopolitical risks. Political unrest and uncertainty may impact the economy. So while Brazil has an impressive rate of interest, politically, it may raise some red flags. Keep abreast of headlines related to the country. Turn to the international section of your daily news source regularly for updates.

How to Play

Experts don't recommend a buy and hold strategy with currencies, where you don't change your position for 20 years. Since the world's economies can be quite volatile, currency traders have a relatively shorter investment outlook of three to five years.

When you buy one country's currency, you're giving up another, like buying euros with U.S. dollars. Like trading stocks on an exchange via an online broker, investors turn to online currency brokers to facilitate the swap. You can buy futures contracts, going long or short, depending on your expectations. To give this a try, offers a free practice account.

Fund Favorites

Kevin Baker, senior financial analyst for Ratings, recently wrote " Top Currency Funds Bet Against the Dollar." The best-performing currency fund from March 31 to June 30 is the CurrencyShares Australian Dollar Trust ( FXA), Baker says. The FXA tracks the amount of U.S. dollars needed to buy an Australian dollar and the fund was up 6.71% in the second quarter of 2008. CurrencyShares has a number of currency exchange-traded funds ( ETFs), ranging from the Swiss Franc to the Japanese Yen. Many even offer monthly dividends.

Next, the CurrencyShares Mexican Peso Trust ( FXM) gained more than 5% on the dollar's continuing weakness versus the peso. The third-place fund, PowerShares DB G10 Currency Harvest Fund ( DBV) also jumped more than 5% in the second quarter.

Mind the U.S. Dollar

One expert tells me it might be time to reconsider investing in the U.S. dollar. "The euro/dollar is close to an all-time high. If the U.S. economy starts recovering you might want to own the U.S. dollar now ," says Prosser. Plus, with the expectation that the Federal Reserve will begin raising the fed funds rates later this year, that may help appreciate the dollar's strength in 2009.

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