What are currencies?
A currency is a unit of exchange that is used to buy goods and services. Most of us are familiar with this concept by the notes or coins used to buy day to day items, or more commonly nowadays, the online transactions. Currencies are issued by countries and can be used within the country of origin as well as in international transactions.
You’re probably familiar with a few major global currencies. For example, the US dollar (USD) is the currency used in the United States. The Euro (EUR) is used in many European countries, including Germany, France, and Italy. The British pound (GBP) is used in the United Kingdom.
Currencies are an important aspect of investing and can be a way to diversify your portfolio. If you’ve got any investments in other countries, it’s likely that even without knowing it, you’re investing in other currencies in some way. This is because you will be buying stocks that are dependent or even listed in another currency.
But some will choose to simply buy currencies directly and hold them, to try and make a profit. When investing in currencies, you're essentially betting on the relative strength or weakness of one currency against another. For example, if you think the US dollar will appreciate (aka go up in value) against the Euro, you might buy USD/EUR currency pair.
KEY TAKEAWAYS:
- Currency is a unit of exchange used to buy goods and services
- Currencies are issued by countries and used in international transactions
- Major currencies include USD, EUR, and GBP
- Investing in currencies involves betting on their relative strength or weakness against each other
Pros of investing in foreign currencies
- Diversification: Investing in currency can diversify your portfolio and reduce risk. Currencies may not move in the same direction as stocks or other assets, which can help protect your investments from market volatility.
- Liquidity: The currency market is the most liquid financial market in the world, which means that buying and selling currencies is generally easy and fast. This makes it easier to enter and exit positions quickly, in other words, trade very easily.
- Accessible: Currency trading is accessible to individual investors (so not big banks or institutions), which means you don't need to be a professional trader or work for a financial institution to participate.
Cons of investing in foreign currencies
- Risk of Loss: The value of currencies can be volatile and can fluctuate rapidly, leading to significant losses for investors. Currency trading can involve a high level of risk and it is worth saying that it’s not suitable for all investors.
- Complex Markets: The currency market can be complex and difficult to navigate, particularly for beginner investors. There are people who spend their entire careers dedicated to understanding the currency market, so don’t beat yourself up if it’s overwhelming!
- Political and Economic Risk: Currency values can be affected by political and economic events, such as elections, government policies, and global economic trends. These factors can be difficult to predict and can lead to significant losses.