An exchange traded fund (ETF) is an investment fund traded on a stock exchange. ETFs have many types and currency ETFs are investment vehicles that belong to the ETF family. If you are unsure how ETFs work, read our in-depth article that discusses these investment forms in detail. And now about currency ETFs.
How do currency ETFs work?
A currency ETF is a managed fund that allows investors to gain exposure to changes in foreign currency markets. Currency ETFs track the price movement of either a single currency or a basket of currencies. For example, if you buy the FXE ETF, which tracks the price of the euro, the value of your position will depend on the euro/US dollar exchange rate.
Currency ETFs usually consist of cash deposits, short-term bonds denominated in the underlying currency and forex derivative contracts. If you trade a currency ETF, you will not end up on a derivative market as these funds are traded on stock exchanges, similar to stocks.
Currency ETFs are most often used for hedging purposes, speculating on trends in forex markets or diversifying an investment portfolio. Similarly to all other forms of investment, currency ETFs also come with risks.
Tracking currency markets is no easy feat. These markets are typically moved by a wide range of factors, including macroeconomic changes such as interest rate decisions by central banks, data releases (i.e. inflation, GDP, etc.), as well as global economic developments and political events. Any event that has an impact on the stability or effectiveness of a government may have an impact on the price of the given country’s currency. As a result, currency markets are highly volatile and rather hard to predict.
Difference between currency ETFs and forex
Since currency ETFs revolve around the exchange rates of specific currency pairs, you might raise a question, if there is a difference between currency ETFs and forex. The answer is yes.
Currency ETFs are easier to trade as they can be purchased on stock exchanges while forex is traded in an over-the-counter (OTC) market. You don't need a forex account to trade currency ETFs.
Although the price of a currency ETF depends on the spot price of the underlying currency, in some cases currency ETFs do not mirror the exact spot market price. Since ETFs are exchange traded, their value also varies on investors buying and selling the ETF itself. Yet another difference is that currency ETFs can be traded only when the stock market is open, which is a narrower window as forex markets are open longer.
Types of currency ETFs
The selection of currency ETFs is immensely wide and the various funds are built to track the world's most common currency pairs. Here are some examples of the largest currency ETFs based on assets under management (AUM).
- ProShares Bitcoin Strategy ETF (BITO)
- Invesco DB US Dollar Index Bullish Fund (UUP)
- Invesco CurrencyShares Swiss Franc Trust (FXF)
- Invesco CurrencyShares Euro Trust (FXE)
- Invesco Currencyshares Japanese Yen Trust (FXY)
- Invesco CurrencyShares Canadian Dollar Trust (FXC)
- WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU)
- Invesco CurrencyShares British Pound Sterling Trust (FXB)
- Invesco CurrencyShares Australian Dollar Trust (FXA)
- ProShares UltraShort Euro (EUO)
- Invesco DB US Dollar Index Bearish Fund (UDN)
Interestingly the currency ETF with the largest AUM is actually a cryptocurrency ETF, ProShares Bitcoin Strategy ETF which is linked to the price of Bitcoin.
What else do you need to know about ETFs?
Want to know more before deciding which is the best ETF for you? Check out these articles to deepen your knowledge:
- What is the difference between mutual funds and ETFs?
- What is the difference between US and EU ETFs?
- What does an ETF portfolio mean?
- What is an ETF expense ratio?
- How to invest in ETFs?
- How liquid are ETFs?
- How to buy Vanguard ETFs?
- How to buy iShares ETFs?
- What are sector ETFs?
- What is passive investment?
- Are US ETFs only available for US residents?
- How to choose your ETF
How can I buy ETFs?
For more info, click here to learn how to buy ETFs online.