Forex Blog: Currency Trading News & Analysis.

March 3rd 2005

How to Trade on a Weaker Dollar

The most most obvious way to earn money as the dollar declines involves shorting dollars (buying foreign currencies). In the medium and long term, these non-dollar currencies can be re-converted into dollars for a seemingly risk less profit. However, currency trading is typically a highly leveraged proposition, for in absolute terms, currencies are not nearly as volatile as equities. Leveraging, which is essentially trading on margin allows traders to magnify small changes in exchange rate into large profits. However, when times are bad, losses are magnified by the same factor. In addition, when trading on margin, interest must be paid on the money that your broker loaned you, which can significantly eat into returns. For those of you who are reluctant to trade currencies, because of the inherent risks, there is a simpler, less risky way to earn money when the dollar declines: buy foreign equities.

Most of these stocks trade in the form of American Depository Receipts. Basically, an American holding company will purchase a large block of shares of the foreign company, and the share prices trade on an American exchange and are quoted in dollars. As a result, no foreign exchange is necessary to invest in ADR’s. In any event, when you buy a foreign stock in the form of an ADR, the net return on investment is equal to the change in the stock price + change in the exchange rate that took place while you were holding the ADR.

The best ADR’s to invest in are usually those which pay dividends, so that you receive income while you hold the stock. If the dollar depreciates, these dividends (which are denominated in foreign currencies) are worth more USD. Foreign banks, that do not have large USD holdings and that conduct the majority of their business outside of the US are excellent investments, as the value of deposits they hold in foreign currencies, appreciates as the USD depreciates. There is one caveat when investing in foreign companies: those which conduct much of their business in the US or in terms of Dollars are actually less profitable as the Dollar depreciates. As a general rule, these companies should be avoided.

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Posted by Adam Kritzer | in Investing & Trading | 1 Comment »

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One Review of “How to Trade on a Weaker Dollar”

  1. John Says:

    Do you have an opinion on the ProFunds Rising and Sinking Dollar Index funds? They offer two funds based on the Dollar Index of a basket of six currencies and structure the funds as either short or long.
    The attraction for me is that the funds appear at first glance to be less volatile so it might be more appropriate for a medium term investment time frame than a Forex trading account.

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