Foreign currency actions and currency risk (3/4)

We saw in our last article that currency risk could be limited by diversifying one's portfolio in local currency, but that this method was limited and not as obvious as it might first appear. In any case, this strategy alone is not sufficient. It is therefore advisable to find other approaches that allow one to free oneself from currency fluctuations. One of these is to play on the foreign exchange market. This is an effective solution for those who master this type of investment and which, like bonds, allows one to diversify the type of asset in which one invests.

THE Forex gained popularity during the years 2000-2010, thanks to the mediocre performances of the stock market. This market has the advantage of being open 24/24, of being very liquid, of being able to play on the rise as well as on the fall, of being decorrelated from the stock market, and therefore of being able to theoretically generate an absolute performance. In addition, it allows to activate a leverage effect, by betting on more than what was invested, and therefore amplifying the gains (but also the losses). Many have even decided to do without stocks altogether and only play on currencies, which can also explain the increased fluctuations in currencies and speculation on the CHF.

To protect yourself against currency risk, simply take a position opposite to that of the foreign asset in possession. For example, to fully hedge against a fall in the dollar, one would have to play against the greenback for an amount equivalent in dollars to the shares in possession. The advantage, if it is one, is that thanks to the leverage effect it is not necessary to own all these dollars. It is also possible to hedge only partially against this risk, by speculating only against a part of the dollar value of the portfolio.

The growing popularity of the currency (and commodity) market reminds us a bit of the Internet brokers of the late 1990s, when almost everyone opened an account to buy stocks tied to dotcom companies. Some will find it profitable, but it seems that there are too many kids in that playground playing at the same time these days.

In addition, the currency risk is covered by adding another risk, that of leverage, which allows putting on the market a sum up to 500 times greater than that which the broker has. Too much leverage is also the cause of ruin for many individuals while Forex is 2 to 3 times less volatile than the stock market. It is therefore advisable to remain very cautious if you wish to take this path.

In our next article, we will discuss a final original method for hedging against currency risk.