Diversification is crucial to spreading risk. In other words, those who invest in different asset classes, regions and industries spread their risk in an efficient way. This is how investors usually diversify their portfolio. This also works with currencies. If, for example, the stock and bond markets collapse, currency positions can limit losses in the portfolio. In addition, investors can manage their currency risk with this asset. For example, if you are invested exclusively in equities from the euro zone, you can cushion the currency risk in your portfolio by "buying" another currency.
Private investors can trade foreign exchange simply and easily with contracts for difference (CFDs). Currency pairs serve as the underlying assets. Depending on market expectations, investors invest in one currency outperforming another. An example is the currency pair Euro/US Dollar, which is popular among many investors. If you expect the euro to appreciate against the greenback, you invest in this market opinion with a long CFD on euro/US dollar. The term "long" refers to the currency mentioned first, in this case the euro. If, on the other hand, you believe that the dollar will perform better than the euro, you buy a short CFD on the same currency pair.
Important: Contracts for Difference are leveraged investments because investors only deposit a margin with the broker and not the full value of the reference value. This means that CFDs allow for leveraged profits if the investor's market expectation is fulfilled. For example, a leverage of 10 means that the price of the long CFD on the euro/US dollar will rise by 10 percent if the euro gains 1 percent against the greenback. However, the leverage also works in the other direction: If the market expectation does not come true, the CFD will lose value accordingly. In the example above, if the dollar gains 1 percent against the euro, the price of the long CFD would fall by 10 percent.
