Foreign Currency Investment Strategies
Foreign currencies are one of the largest and most liquid markets in the world. Twenty-four hours a day, every day of the week, investors trade billions of dollars in foreign currencies. These investors use a variety of strategies to maximize their returns or to mitigate risks. Many of these strategies are complex, but they often have simple underpinnings.
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Foreign Currency Hedging Strategies
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The most basic kind of foreign currency strategy in use is simple hedging. Foreign currency hedging is not designed to generate profits. Instead, it is meant to lock in gains. When investors have assets or liabilities denominated in different currencies, currency fluctuations can affect their profits in unpredictable ways. These investors will often use hedging to balance this risk: if an investor expects a large payment in yen next year, he can make a bet that the yen will decline in value. If the yen drops, the payment will be lower, but the bet will pay off to compensate and vice-versa.
Global Macro Strategies
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Many foreign currency investors use a global macro strategy. They try to identify long-term trends in currencies based on the economic policies and performance of the countries they study. For example, an investor might decide that the United States government's deficit will require the government to borrow or print more money. This could lead to a lower dollar value. This investor might use foreign currency markets to bet that the U.S. dollar would decline in value in comparison to other currencies.
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Technical Analysis
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Technical analysis uses price and volume signals to determine when to buy and sell investments. Investors that use these strategies look at charts of recent price performance and use this to guess what the future will hold for a given asset. An investor might determine that the euro has strong momentum, for example, and might then invest in euros to benefit from this trend. Another investor might notice that the yen has always changed direction when it reaches a certain exchange rate in comparison to the dollar and might bet on this trend.
Quantitative Analysis
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Some investors write computer programs that aggregate vast amounts of market data in order to find patterns. A quantitative analyst might determine that sudden increases in a currency's value relative to another currency will often revert. This investor would bet against that currency if it spiked in price. Another program might determine that there are cases in which two currencies strongly correlate and would bet that if this correlation breaks down, it will eventually be restored.
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References
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