Most investors are used to the idea of purchasing a stock or bond to hold as an investment. Investing in currencies is somewhat different, although you can certainly purchase and hold a foreign currency that you expect to appreciate over time relative to another currency.
This currency investment process is traditionally done by performing a foreign exchange or forex transaction where you simultaneously buy the currency you think will rise and sell a currency you expect to fall against it.
Since this transaction represents the barter or exchange of amounts of different currencies of equal value, and not an outright purchase of a security or asset like a stock, bond or gold bar, the initial investment in the transaction is zero. Nevertheless, as your purchased currency appreciates against the sold currency due to a favorable exchange rate movement, you will then show a gain on your currency investment.
Choosing a Currency Pair Likely to Appreciate
Investing in a currency via the forex market involves choosing one currency that is expected to appreciate to take a long position in and selecting another currency that you anticipate will depreciate relative to it to take an opposing short position in.
Some of the key factors that tend to make one currency rise relative to another include: higher interest rates, a more stable and creditworthy government, slower money supply growth, a higher trade balance and stronger economic indicators.
Positive and Negative Carry on a Currency Investment
Furthermore, when the currency that you purchase has a higher prevailing Interbank deposit rate, you will typically also receive points for each day that you hold the position past 5pm New York time.
This so-called positive carry trade means that your currency investment earns pips for you each day, although you can still lose if the exchange rate moves against your position.
On the other hand, if your purchased currency has a lower deposit rate than the currency you sold, you will pay away points each day due to the negative carry. Accordingly, your currency investment in this case will be based on the expectation of a favorable exchange rate movement above and beyond the transaction's negative carry over the time frame you expedct to hold the currency investment.
Long Shot Currency Investments
Some currencies have been severely depreciated as a result of geopolitical conflicts such as wars, and they might make an attractive long shot investment for someone willing to invest their funds into a currency transaction with relatively little hope of making a positive return, although the return could be a large one, if it ever did materialize.
Buying the Iraqi Dinar is an example of this sort of long shot currency investment. The currency of Iraq fell sharply after the most recent invasion of the country and some people rather optimistically expect the Dinar to recover much of its value once the conflict ends due to Iraq's huge oil reserves.
This situation has attracted rather active speculation in recent months among investors who have become convinced that the Iraqi Dinar may recover substantially now that the Iraqi war seems to be concluding. Nevertheless, even if this transaction turns out to be profitable on paper, the potential difficulty in ever being able to exchange your Dinars for another major currency makes this seem like even more of a long shot investment.