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What is currency and currency trading?

The term currency can be associated with dollars and cents – but as the Colonial First State Investments team explains, it can actually represent much more.

On the surface, currency serves as the primary medium for the exchange of goods and services – that is, money, which encompasses coins, notes and credit cards and, more recently, non-physical currencies like bitcoin. However, currency can be more complex than just dollars and cents. For example, did you know that the value of currency regularly moves – and that these fluctuations represent a different kind of investing, known as currency trading?

What are some of the main currencies?

There are about 180 national currencies in circulation around the world. Many countries issue their own currencies – for example, Australia’s official currency is the Australian Dollar (AUD), while Japan’s official currency is the yen. However, some currencies are more widely adopted. Take the euro (EUR), for example, which is used by many countries within the European Union – including the likes of France, Germany and Spain.

 

 

Another widely used currency is the US Dollar (USD) – the official currency of the United States, which is considered the world’s largest economy. The USD is therefore one of the most popular currencies – one that not only serves as a standard unit of currency for major commodities such as oil or gold, but one that many countries are exposed to through day-to-day trade activity. The USD is often quoted in the media and can be used as a benchmark to determine the strength of other currencies.

What’s an exchange rate?

If you’ve ever travelled overseas and converted your money into another currency, it’s likely you’ve heard of the exchange rate – that is, the value of one currency versus another. If you’ve noticed that a currency has less buying power (meaning, you’re getting less foreign currency than you’re buying) in one country compared to another, that’s because the value of currency moves – usually based on trade, political, financial and economic factors, as well as supply and demand in the currency market.

 

 

When a currency increases in value, you may need more of your money to buy it. For example, the AUD traded at about 0.667 USD at the end of May 2020. At this time, one AUD bought 66.7 USD – or, to put it another way, you needed about AUD$1.50 to buy USD$1.

What is currency trading?

Fluctuations in the exchange rate enable another form of investing, known as currency trading. This is done through the trillion-dollar currency market, known as foreign exchange, (forex or FX) – the world’s largest investment market. Accessed largely by experienced investors, the FX market is highly liquid (meaning investments are easily converted into cash) and is open during regular trading sessions across Europe, Asia and the United States (24 hours a day) from Monday to Friday.

 

 

Currency trading is done in pairs – that is, you sell one currency to buy another. Trading is typically confined to 18 currency pairs, with the most commonly traded currencies including the AUD, the USD, the Canadian Dollar (CAD), the EUR, and the British Pound (GBP). This means that there are fewer, simpler options compared to the thousands of stocks listed on global share markets.

How does currency impact financial markets?

Many of the same influences that cause fluctuations in exchange rates can also cause fluctuations in share markets – but they can even impact each other. For example, if the Australian share market is rising, it’s possible that international investors will want to invest in it – but to participate, they will need to access the AUD, making the AUD more in demand and therefore more valuable to investors.

 

 

Conversely, the exchange rate between currencies can have an impact on financial markets. For example, if an Australian wanted to invest AUD $100,000 in US-listed shares on 19 March and converted the AUD into USD, they would have received only USD $57,000 worth of stock as the exchange rate at that time meant one AUD bought 0.57 USD. This compares to 10 June, when the exchange rate between the AUD and USD was higher – with one AUD buying 0.70 USD. On that day, an investor could buy $70,000 worth of stock for the same Australian Dollar cost. While the USD price of the stock may have changed between those dates, you can see how changes in exchange rates can impact an investor’s financial position. If their position is impacted, it’s possible they wouldn’t go ahead with their investment – meaning less demand for the USD and less investment in that market.

Does Colonial First State invest in currency?

Colonial First State offers more than 150 investment options across a range of asset classes to help Australians achieve their individual retirement goals. Some of these options may have exposure to the FX market – for example, if they are part of a cash, fixed interest or alternatives portfolio. Exposure to currency has the potential to provide investors with additional portfolio diversification and can also help with the generation of investment returns (in alignment with fund objectives). But it can be important to remember that there are risks involved with all investments, including currency – particularly given the impacts Coronavirus has had on financial markets and returns.

Find out more

Understanding the different factors that can have an influence on financial markets can help you make more informed decisions for your financial future. For more than 30 years, Colonial First State has helped Australians with their superannuation, investment and retirement needs. The team also shares news, insights and helpful resources to help members further their financial understanding. Visit www.colonialfirststate.com.au to learn more, speak to your financial adviser, or call us on 13 13 36 from Monday to Friday between 8.00 am and 7.00 pm (Sydney-time).

Disclaimer:

Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (CFSIL) is the issuer of super, pension and investment products. This document may include general advice but does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) and Financial Services Guide (FSG) carefully, assess whether the information is appropriate for you, and consider talking to a financial adviser before making an investment decision. The PDS and FSG can be obtained from www.cfs.com.au or by calling us on 13 13 36.

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