Dollar Up/Down ETFs

Foreign exchange, a.k.a. forex, has surged in popularity in recent years.  Yet, many investors still don’t know a lot about this asset class, or how to properly integrate it into their portfolios.  Trading forex can be a dizzying process.  The market is open 24-hours a day starting with the Monday open of Tokyo’s markets and trading lasts until 4 PM New York time on Friday.  By some estimates, over $3 trillion a day is traded in the forex market – more than all of the world’s bond and stock markets combined.

Throw in the fact that trading forex can be risky and time consuming – many investors ignore what can be a highly profitable addition to their portfolios.  As forex gained popularity over the past few years, alongside ETFs, it was only a matter of time before currency ETFs burst onto the scene.

While the number of currency-linked ETFs has grown in the past couple of years, many still do not have a comfortable trading volume.  That’s why we’re going to focus on two with above-average liquidity:  PowerShares DB US Dollar Index Bullish (UUP) and its bearish counterpart, PowerShares DB US Dollar Index Bearish (UDN).  UUP trades nearly $18 million a day and the UDN close to $14 million.  Both ETFs represent fine alternatives for ETF investors new to the currency game.  Plus, they’re easy to understand.

The bullish ETF fund holds U.S. dollar futures positions against an index of the following currencies: the Euro, Yen, British Pound, Swiss Franc, Canadian dollar, and Swedish Krona.  The bearish ETF holds short dollar futures contracts against the same currencies.  Both ETFs have expense ratios of 0.5%.  Investors should also note that since both funds hold futures contracts, capital gains for tax purposes receive 60/40 long term/short term treatment used by the IRS.  This means only 60% of your profits are considered long-term.

It would be counter-productive to hold both UUP and UDN in a portfolio at the same time.  Before jumping in, be sure to establish a firm grasp on which way the dollar is headed for the time frame that interests you.  As of today, a bearish slant on the dollar seems to be in order.  Low interest rates, ballooning deficits, a voracious spending appetite in Congress, and a weak economy don’t bode well for the dollar’s health.  UDN rests comfortably above both its 50 and 200-day moving averages.  If it starts to fall, it should find support in the $26.25 area.

The other side of the argument is that the UUP may be oversold.  It hasn’t touched either important moving average in weeks.  If it can make a run above $24, it should bump into resistance at $24.50, also the 50-day moving average.

No matter which way the dollar swings, investors should be positioned to take advantage of those swings, and these two ETFs can help them do just that.

Disclosure:  long UDN