More investors are jumping into the risky currency markets in a search for higher-yielding alternatives to stocks and bonds—and financial-services firms are making it easier than ever for them to do so.

New rules set by the U.S. Commodity Futures Trading Commission, or CFTC, designed to protect investors go into effect on Monday. Still, there are huge risks involved.

In a foreign-exchange trade, investors trade in pairs, buying one currency and selling another. Investors can borrow large amounts against a relatively small actual investment, potentially magnifying their gains—and losses.

The new CFTC rules will prohibit retail forex dealers from offering more than 50-to-1 leverage for major currencies such as the dollar and the Japanese yen or 20-to-1 leverage for more-exotic currencies. That means an investor putting up $1,000 can trade as much as $50,000. Previously, leverage of 100-to-1 was common.

Investor interest in currency trading is heating up. Brokerage firms such as TD Ameritrade Holding Corp., Interactive Brokers Group Inc. and E*Trade Financial Corp. report seeing strong gains in volume and have ramped up marketing and educational efforts. In August, TD Ameritrade rolled out futures and forex trading systems—previously available only to active traders—to all of its customers. While equity volumes at the brokerage were down in July, trading volumes in futures and forex were up 60% and 34%, respectively, says Steven Quirk, senior vice president of TD Ameritrade's Trader Group.

The CME Group Inc.'s Chicago Mercantile Exchange, which rolled out smaller retail-oriented forex futures contracts last year, saw trading volumes in that product jump 125% in September over year-ago levels, says Derek Sammann, head of FX and interest-rate products at CME.

Many of the popular foreign-exchange trading sites—including FXCM Holding LLC's FXCM.com, Gain Capital Holdings Inc.'s Forex.com, and Oanda Corp.—offer features designed to attract retail investors. At Oanda, which publishes clients' aggregate long and short positions for major currency pairs to give investors an indication of market sentiment, traders can buy and sell currencies for as little as $1. Earlier this year, Forex.com launched a new pricing structure that essentially reduced spreads on trades by as much as 50%.

Wall Street firms have jumped in with their own proprietary forex-trading services in recent years. Deutsche Bank AG's London-based dbFX and Citigroup Inc.'s CitiFX Pro are aimed at active traders and small institutions. As a unit of Citigroup, the Citi platform is eligible for FDIC insurance, which covers cash deposits up to $250,000.

Forex trading can help diversify one's portfolio, since currencies often move independently of stocks, bonds and other traditional investments.

But be warned: Currencies can bounce around sharply on an array of factors ranging from minor changes in interest-rate expectations to swings in economic data. And depending on how much leverage is used, investors could be responsible for losses that far exceed the amounts they invested. Investors also face greater risks in the over-the-counter retail-currency market, which is less regulated than the stock and futures exchanges.

Nasser Bakizada, a full-time trader in Washington who is buying the euro and other foreign currencies and shorting the dollar, manages his risks by making sure he has enough collateral to cover potential losses. Foreign-currency trading "provides a great opportunity but it has to be done very carefully," the 53-year-old Mr. Bakizada says. "The biggest risk is, during volatile times, you can get burned very quickly."

Mutual funds and exchange-traded funds can be an easier and safer way for small investors to get currency exposure. "Some people think of them as a fixed-income substitute that can provide diversification beyond bonds," says Nadia Papagiannis, alternative-investments strategist at investment-research firm Morningstar Inc., which tracks 16 open-end distinct mutual funds and 32 ETFs and exchange-traded notes.

The Oppenheimer Currency Opportunities Fund, launched in June, aims to protect investors' purchasing power mainly by buying the foreign currencies of the U.S.'s major trading partners. John Hancock Funds, which launched the John Hancock Currency Strategies Fund earlier this month, also is adding the fund as an underlying investment in its target-date and target-risk funds. Last month, WisdomTree Investments Inc. launched the WisdomTree Dreyfus Commodity Currency Fund—an actively-managed ETF designed to provide exposure to a basket of currencies of commodity-producing countries.

Investors also can buy foreign-currency certificates of deposit. In July, EverBank Financial Corp. rolled out a CD whose returns are tied to the Deutsche Bank Currency Returns Index, which tracks popular trading strategies. Investors tie up their money for four years, but get principal protection and can earn 100% of the index's returns.

Given the plethora of retail foreign-exchange trading sites, it is important to verify whether a firm or broker is registered with the CFTC and is a member of the National Futures Association. Investors can check on the disciplinary history of an individual firm or broker at www.nfa.futures.org/basicnet.
stocks, bonds & forex trading
source: online.wsj.com