In one of our previous blog posts we have seen what the trap is you can fall in when you invest in foreign stock markets. In this post you will learn a strategy for how to avoid that trap.

The unique catch that foreign stock markets pose to an investor is the currency risk. When we talk now here about foreign stock markets, we assume that these markets use a different currency than the currency in your home country.

Now here is the principle rule:

"Only invest in foreign stock markets (that use a different currency than your own countries currency) if you accept that a steady part of your savings will be invested in those foreign currencies."

If you cannot accept that a certain percentage of your savings is standard invested in these foreign currencies, my suggestion is to invest just in your home market and avoid investments in foreign stock markets.

Steps to Invest in Foreign Stock Markets

If you do accept the principle that you diversify a certain percentage of your savings into foreign currencies, here are the steps to follow:

1. Define what percentage of your savings you want to hold in what currency or group of currencies. For example, you could hold 40% in US Dollars, 40% in Euros and 20% in Asian and stable Emerging Markets Currencies.
   
   
2. Identify the following for each of the currencies or group of currencies that you want to keep investments in:
   
   
   • The stock market index funds that you want to hold when the long-term trend in the stock market for that currency region is up (trend following).
     
     
   • The savings account, money market account or short to medium term bond funds that you will park your money in when the long-term trend in the stock market for that currency region is down.
     
     
3. You invest your savings into the different funds for the different currency regions according to the percentages that you set under “1” and as defined in “2” according to the direction of the long-term trend in the stock market.
   
   If you do not have any substantial holdings in foreign currencies and you start implementing this strategy, my suggestion would be is to implement it in 2 or 3 steps spread out over a few months. You are in that way less dependent on the currency exchange rate of the day.
   
   When the direction of the long-term stock market trend changes for a certain currency region, you move your holdings accordingly from the stock market to the cash/bonds or vice versa.
   
   
4. Now every 6 months, you rebalance your savings over the different currencies.
   
   
   • You calculate all your foreign holdings back to the value in your own home currency. Add them all up to calculate the total value of your holdings.
     
     
   • You compare now the actual percentage of your total holdings that is invested in each currency with the percentage that you set out with.
     
     Over time your actual percentage will probably have changed compared to what you set out with due to differences in the performance of the different markets and changes in the exchange rate.
     
     For example, if you had set out with a division of 40%/40%/20%, this could now have turned into 35%/42%/23%. Note that these changes in percentages do not tell you if the total value of your holdings has gone up or down during the last 6 months. Most of the time it will have gone up; sometimes it has gone down.
     
     
   • Now you sell and buy the appropriate holdings to re-balance your portfolio back to the original division over the different currencies. For example, sell holdings to bring the 42% and 23% back to 40% and 20% and buy to increase the 35% holdings to 40% of your total.
     
     You do this only if these orders are in size much bigger than the commissions you have to pay for these trades. Otherwise it does not make sense.
     
     By re-balancing in this way, you systematically buy low and sell high.

With the major currencies in the world moving up and down compared to each other over time, this strategy is effective to avoid the currency trap of investing in foreign stock markets. And by re-balancing regularly, you can even make some extra gains.

This is only a very short description of this strategy and I can imagine that it raises quite a few questions. If you have any question on this approach, I will be very willing to try to answer them for you. Just leave your questions as a comment below or contact me here.

If you like this strategy for investing in foreign stock markets and think that your friends may be able to use it, please like or share it on facebook.

Investing in foreign stock markets and being invested in foreign currencies is not something that everyone will feel comfortable with. But if you are up to it, foreign markets could provide you with extra gains and reduce your exposure to a single currency. In current times with all the uncertainty around the US Dollar and Euro, that is a bonus as well.