The steep drop in the value of the dollar has many individual investors flirting with dipping into foreign currency trading in order to defend themselves against the greenback's weakness.
They should forget about it. The risks are far too great for individual investors to try trading foreign currencies directly, financial experts warn. Indeed, it is a job best left to the big-name professionals who can offer indirect — and safer — ways to get in on the ebb and flow of the dollar.
"Joe from Dubuque would be insane to play this game," said Dan Seiver, a finance professor at San Diego State University. "It's unlikely most individuals would have any idea what's going on all over the world 24 hours a day and it has the potential for an enormous amount of loss."
Investors and savers are likely to run into temptation, though, as financial institutions are pitching a myriad of new products and funds that make it easier to dabble in currencies.
EverBank World Markets, for example, offers traditional banking accounts and CDs in foreign currencies. An investor could buy $10,000 worth of, say, Aussie dollars and gain on the better interest rates in Australia.
Consider what's happened this year: The Aussie dollar is up 9 percent through the first six months. Investors who bought $10,000 worth of Aussie dollars in January when they were going for 87 cents to the U.S. dollar saw that rise to 95.5 cents, boosting the principal to 11,494.25 Aussie dollars. Add in half of the annual 5.24 percent interest rate and there's another 301.72 Aussie dollars for a total of 11,795.97.
Convert that account back to U.S. dollars today and that $10,000 investment has grown to $11,265.15 — an 11 percent kick.
"Buying a currency is like buying a stock of a country," said Chuck Butler, president of EverBank World Markets. "Make sure to do research... . All the same types of things you do to buy stocks."
While holding savings accounts or CDs in foreign currencies opens you to risk, trading currencies themselves is a real hot potato. Currency trading, which can be heavily leveraged, requires constant surveillance because of its sharp volatility.
What makes foreign exchange markets so scary is the huge leverage on these accounts, many at 30-to-1, with the brokerage firm fronting the bulk of the money. At that rate a $100,000 investment could give an investor access to $3 million worth of euros or yen.
That kind of leverage magnifies gains but can also result in steep losses.
"Currency markets are inefficient," said James Mitchell, director of the London-based fixed-income portfolio management for Russell Investments. "Investors must tread carefully because of their volatility."
Still, international diversification offers protection against a falling dollar. "If you're invested in equity markets it makes some sense to be globally diversified," Mitchell said.
Seiver recommends these three methods of hedging your bets in you think the dollar will continue to weaken: opening accounts in different currencies, where allowed; investing in international mutual funds that hold only foreign shares (versus global funds that include U.S. holdings); or buying specialized mutual funds or exchange-traded funds that move inversely to the dollar. He holds the Pro Funds Falling U.S. Dollar Fund.
"It's the best way to indirectly have a play on the weak dollar," he said.
Jennifer Waters is a MarketWatch reporter, based in Chicago.