Forex, also known as foreign exchange, FX, or currency trading, is a decentralized global market where all the world’s currencies trade. The forex market is the largest, most liquid market in the world with an average daily trading volume exceeding $5 trillion. All the world’s combined stock markets don’t even come close to this. But what does that mean to you? Take a closer look at forex trading and you may find some exciting trading opportunities unavailable in other investments.

Why choose forex?

Currencies are complicated, and we believe that taking FX risk is not rewarded over the medium to long-term investment horizons of most investors. We generally see FX as a portfolio risk that needs careful assessment and management, rather than as an opportunity to generate additional returns. Why hedge? With no clear return benefit over time, the key aim for many long-term investors is to reduce volatility. Currency moves can greatly increase the volatility of portfolio holdings. This is particularly the case for low-yielding fixed-income assets, as the green bars in the Keeping, a lid on volatility chart below show.

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We suggest investors hedge most of their FX exposures in major developed markets (DM). We favor fully hedging fixed-income allocations and leaving a portion of equity holdings unhedged, especially for European investors. We give our preferred hedge ratios for standard portfolios, and explain why we favor permanent hedges over dynamically trying to maintain a set level of FX exposures.

We see some room for taking FX risk in the short term, keeping in mind the liquid, 24-hour market is often the first to respond to unexpected events. We outline what we see as key drivers of currency moves: policies affecting interest rate differentials, investor sentiment and other technical factors, valuations, and economic fundamentals. We conclude we currently have a low conviction on most currencies.